📝 Study Notes: Determinants of Short-Run Aggregate Supply (SRAS)

Hello future economists! This chapter is fundamental to understanding how the macroeconomy operates. We are diving into Aggregate Supply (AS), specifically the factors that determine how much an economy can produce in the short run. Mastering this helps you understand inflation, economic growth, and the impact of government policy.

Don't worry if the graphs seem intimidating—we will break down the causes of shifts step-by-step!

1. Understanding Short-Run Aggregate Supply (SRAS)

What is Aggregate Supply?

Aggregate Supply (AS) is the total quantity of goods and services that firms in an economy are willing and able to supply at a given price level.

The Short-Run Aggregate Supply (SRAS) curve looks specifically at supply during a period when at least one factor of production is fixed (usually capital) and, critically, money wage rates are sticky or fixed.

Key Term: Short Run (In macroeconomics, a period where production costs, especially wages, do not fully respond to changes in the price level.)

Why is the SRAS Curve Upward Sloping?

The SRAS curve slopes upwards from left to right. This shows a positive relationship between the overall Price Level (P) and the Real National Output (Y).

  • The Logic: If the overall price level in the economy rises (i.e., inflation occurs), but the costs of production—especially the money wages paid to workers—remain the same (fixed in the short run), firms' profit margins increase.

  • Higher profits incentivize firms to expand production and supply more goods and services. Therefore, P rises, Y rises.

Think of it like running a coffee shop: If the price you can sell coffee for goes up, but your rental cost and your employee wages haven't changed yet, you will want to brew more coffee!

Movement Along vs. Shift of the SRAS Curve (Crucial Distinction)

Understanding the difference between a movement along the curve and a shift of the entire curve is essential for macroeconomic analysis.

A. Movement Along the SRAS Curve

A movement along the curve is caused only by a change in the Price Level.

  • If the price level increases (e.g., due to higher AD), we move up the curve (higher output).

  • If the price level decreases, we move down the curve (lower output).

B. Shift of the SRAS Curve

A shift occurs when the costs of production change, meaning firms are willing to supply a different amount of output even if the overall price level remains unchanged.

  • Increase in SRAS (Shift Right): Production costs decrease.

  • Decrease in SRAS (Shift Left): Production costs increase (e.g., an increase in 'cost-push' inflation).

Quick Review:
Price Level Change = Movement Along SRAS.
Production Cost Change = Shift of SRAS.

2. Key Determinants that SHIFT the SRAS Curve

The short-run aggregate supply curve shifts when there is a change in the costs of production. If production costs rise, SRAS shifts left (less supply). If production costs fall, SRAS shifts right (more supply).

The syllabus identifies four main determinants that affect these costs. We can use a simple mnemonic to remember them: W.I.R.P.

A. Money Wage Rates (W)

Money wage rates refer to the amount of money paid to workers per unit of time (e.g., £15 per hour). Labour is often the largest cost for businesses.

  • If Money Wage Rates Increase: This directly raises the firm's cost per unit of output (unit costs).

    Example: After a period of low unemployment, workers successfully negotiate higher pay rises.

    Effect: Costs rise $\rightarrow$ Profits fall $\rightarrow$ SRAS shifts LEFT (inwards).

  • If Money Wage Rates Decrease: (This is less common, but happens if unemployment is high or unions are weak.) Unit costs fall.
    Effect: Costs fall $\rightarrow$ SRAS shifts RIGHT (outwards).

Did you know? Even if a company's total revenue is high, if its money wage rates are rising faster than its output, its profitability will fall, discouraging future production.

B. Indirect Taxes (I)

Indirect taxes are taxes levied on goods and services rather than on income or wealth (e.g., Value Added Tax/VAT, excise duties).

  • If Indirect Taxes Increase: These taxes act like an extra cost for the firm. The firm must pay the tax to the government, increasing the total cost of supplying the product.

    Example: The government raises the tax on fuel used for transportation by businesses.

    Effect: Costs rise $\rightarrow$ SRAS shifts LEFT.

  • If Indirect Taxes Decrease (or Subsidies Increase): A decrease in tax (or the introduction of a government subsidy) effectively lowers the cost of production.
    Effect: Costs fall $\rightarrow$ SRAS shifts RIGHT.

C. Raw Material Prices (R)

This covers the cost of all physical inputs needed for production, often referred to as commodity prices (oil, metals, agricultural goods, energy).

  • If Raw Material Prices Increase: Since many commodities are traded globally, external shocks (like geopolitical conflicts or resource shortages) can drastically increase these costs.

    Example: A sudden surge in the global price of crude oil increases the cost of energy and plastics for all manufacturers.

    Effect: Costs rise $\rightarrow$ SRAS shifts LEFT. (This is a classic example of a 'cost-push' shock).

  • If Raw Material Prices Decrease: An abundance of supply or falling global demand for commodities lowers costs.
    Effect: Costs fall $\rightarrow$ SRAS shifts RIGHT.

D. Productivity (P)

Productivity is output per unit of input (e.g., output per worker). It determines how efficiently firms use their resources. This is arguably the most important factor in cost control.

Productivity changes affect unit costs:

$$ \text{Unit Cost} = \frac{\text{Total Cost}}{\text{Total Output}} $$

If productivity rises, Total Output increases faster than Total Cost, meaning Unit Cost falls.

  • If Productivity Increases: This often comes from better technology, better training, or increased efficiency. Firms can produce the same output for less cost.

    Example: A factory installs new, faster machinery, meaning fewer workers are needed to produce the same number of cars.

    Effect: Unit Costs fall $\rightarrow$ SRAS shifts RIGHT.

  • If Productivity Decreases: (Perhaps due to outdated machinery or a poorly skilled workforce), firms become less efficient.
    Effect: Unit Costs rise $\rightarrow$ SRAS shifts LEFT.

Summary Table of SRAS Shifts (W.I.R.P.)

Determinant Change (e.g., Rises) Impact on Unit Costs Shift in SRAS
Wages Higher Wages Higher Cost LEFT (Inward)
Indirect Taxes Higher Taxes Higher Cost LEFT (Inward)
Raw Materials Higher Prices Higher Cost LEFT (Inward)
Productivity Higher Productivity Lower Cost RIGHT (Outward)

Key Takeaway: The Short-Run Aggregate Supply (SRAS) is all about production costs. If firms face higher costs for inputs (wages, materials, taxes), they supply less at any given price level, causing the curve to shift inwards. If costs fall, the curve shifts outwards, boosting output.

Don't confuse these short-run factors with the long-run factors (like changes in the quality or quantity of the overall workforce or capital stock), which we will look at when studying LRAS!