Short Run Aggregate Supply

EdExcel AS Economics 2.3.2

Introduction to Aggregate Supply (AS)

• Aggregate supply (AS) is the quantity of goods and services that producers in an economy are willing and able to supply at a given level of prices

• Short run aggregate supply (SRAS) is the relationship between planned national output and the general price level

• SRAS shows how much output the economy can generate in the short-term at each price level• A rise in the general price level should stimulate an

expansion of supply• When prices are falling, production may contract

• The main factor causing a shift in SRAS is the resource cost of producing goods and services e.g. unit wage costs

Short Run Aggregate Supply Curve (AS)

General Price Level

Real GDP

GPL1

GPL2

AS

Y1 Y2

A rise in the price level causes an expansion of aggregate supply

The short run AS curve is upward sloping because higher prices for goods and services make output more profitable and enable businesses to expand production by hiring extra labour and other resources.

Short Run Aggregate Supply Curve (AS)

General Price Level

Real GDP

GPL1

GPL2

GPL3

AS

Y1 Y2Y3

A rise in the price level causes an expansion of aggregate supply

A fall in the price level causes a contraction of aggregate supply

The short run AS curve is upward sloping because higher prices for goods and services make output more profitable and enable businesses to expand production by hiring extra labour and other resources.

Shifts in Short Run Aggregate Supply (AS)

Changes in resource (input) prices• Wage costs per unit of output• Labour productivity (higher efficiency ceteris paribus lowers unit costs)• Raw material and component prices such as glass, cement, rubber• Energy costs such the world price of oil, gas and electricity

Business taxes, subsidies, regulations and imported costs• VAT, environmental charges / employment taxes• Changes in the scale and size of government subsidies to certain industries• Business rates + costs of meeting business regulations and other laws• Cost of imported components (affected by the exchange rate +

fluctuations in world commodity prices)

Supply shocks• E.g. A hurricane, a tsunami or the effects of drought, flooding or a political

crisis / civil war which can have an effect on a country’s national output

Shifts in Short Run Aggregate Supply (SRAS)

General Price Level

Real GDP

GPL1

AS1

Y1

AS2

Y2

A shift from AS1 to AS2 is an inward shift of the short run aggregate supply curve

This inward shift in the aggregate supply curve might have been caused by a rise in raw material prices, energy costs, unit labour costs or perhaps an increase in the cost of meeting business regulations.

Shifts in Short Run Aggregate Supply (SRAS)

General Price Level

Real GDP

GPL1

AS1

Y1

AS3

Y2 Y3

A shift from AS1 to AS3 is an outward shift of the short run aggregate supply curve

This outward shift in the aggregate supply curve might have been caused by a rise in labour productivity, or perhaps a decline in energy costs.

External Factors affecting Aggregate Supply (AS)

World oil and gas prices• The UK is a net importer of oil – an input used in many different industries

Energy prices / costs• The UK is also a net importer of energy source such as coal

Other mineral / metal prices• E.g. Rubber, iron ore, rare earths (used in many electronic products)

Foodstuff prices• E.g. International prices for fresh foods, coffee, wheat, cocoa, sugar

Import tariffs / quotas• The UK is a member of the European Union which sets a common import

tariff on different goods and services coming into the EU Single Market

Changes in global oil prices affect aggregate supply

Source: HM-Treasury Databank

US Dollar Oil Price UK Oil Price Year on Year change in oil prices

Year US $ per barrel £ per barrel Per cent

2007 73 36.2 0.9

2008 98 52.1 43.9

2009 63 39.7 -23.9

2010 80 52.0 31.0

2011 111 69.2 33.0

2012 112 70.5 1.9

2013 109 69.5 -1.3

2014 99 60.1 -13.5

2015 (May) 65 42.7 -34.3

Oil is usually priced in US dollars ($) per barrel

Cheaper fuel for motorists and businesses

Decline in value of oil exports + cheaper imports

Possible fall in exploration & extraction in the North Sea

Renewable energy less economically viable

Falling energy costs bring down inflation

As oil exporter, the UK exchange rate may fall

Evaluating Economic Effects of Falling Oil Prices

Wheat prices affect many industries

Source: DEFRA * data for May 2015

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015*

0

20

40

60

80

100

120

140

160

180

200

65.0279.32 80.3

67.4378.88

120.97

137.87

107.05

123.76

169.17179.26175.95

143.06127.15

Pric

e of

whe

at p

er to

nne

in £

s

Falling wheat prices in 2014 and 2015 will cause a reduction in the resource costs for food manufacturers such as cereal producers. If other commodity prices are also falling, aggregate supply will shift outwards.

Long-Run Aggregate Supply (LRAS)

In the long run, the ability of an economy to produce goods and services to meet demand is based on the state of production technology and the availability and quality of factor inputs.

General Price Level

Real GDP

General Price Level

Real GDPYp

Yp is the estimated potential national output in the long run

Yp1 Yp2

An outward shift of LRAS shows a rise in productive potential

LAS1 LAS1 LAS2

Short Run Aggregate Supply

EdExcel AS Economics 2.3.1