Short-Run Aggregate Supply

This section explains Short-Run Aggregate Supply (SRAS) covering, Introduction to Short-Run Aggregate Supply (SRAS) and The Factors Influencing Short-Run Aggregate Supply. 

Introduction to Short-Run Aggregate Supply (SRAS)

Short-Run Aggregate Supply (SRAS) refers to the total quantity of goods and services that producers in an economy are willing and able to supply at various price levels, over a short period, while some factors of production (such as capital and technology) are fixed. In the short run, businesses can adjust output levels in response to price changes, but they are constrained by their current capacity and the availability of certain resources.

This revision guide examines the factors influencing short-run aggregate supply, specifically focusing on:

• Changes in the costs of raw materials and energy
• Changes in exchange rates
• Changes in tax rates

Factors Influencing Short-Run Aggregate Supply

Changes in the Costs of Raw Materials and Energy

The cost of raw materials and energy plays a significant role in determining the short-run aggregate supply, as they are key inputs in the production process for many goods and services.

• Increase in Costs: If the cost of raw materials (such as oil, metals, or food products) or energy (such as electricity and gas) rises, the cost of production for firms also rises. As a result, firms may be less willing or able to produce the same quantity of goods and services at the same price level. This leads to a shift leftward of the SRAS curve, meaning that less output is supplied at each price level.
• Decrease in Costs: Conversely, if the cost of raw materials or energy falls, firms' production costs decrease, allowing them to produce more at each price level. This results in a shift rightward of the SRAS curve, meaning that more output is supplied at each price level.

Example: If oil prices rise significantly, transportation and manufacturing costs will increase, which can lead to higher production costs for businesses. This would decrease the supply of goods and services, leading to a potential reduction in output and economic growth.

Example: A fall in the price of natural gas can lower energy costs for industries that rely on it, such as electricity generation, leading to reduced production costs and potentially an increase in the supply of goods and services.

Changes in Exchange Rates

Exchange rates are the rates at which one currency is exchanged for another. Changes in the exchange rate can affect the costs of imports and exports, which in turn influence the short-run aggregate supply.

• Depreciation of the Currency: When the value of the national currency depreciates (falls relative to other currencies), imports become more expensive for businesses. This increases the cost of imported raw materials, components, and energy, leading to higher production costs. Consequently, the SRAS curve shifts to the left, as firms will be less willing or able to produce the same level of output at each price level.
• Appreciation of the Currency: Conversely, if the value of the currency appreciates (rises relative to other currencies), imports become cheaper. This reduces the cost of imported raw materials, energy, and other inputs, making it easier for firms to produce goods and services. This results in a shift rightward of the SRAS curve, as firms can produce more at each price level.

Example: If the British pound depreciates against the US dollar, the cost of importing raw materials like oil, which is priced in dollars, rises. This can increase production costs for businesses and reduce the overall supply in the economy.

Example: If the pound strengthens against the euro, imports from the Eurozone become cheaper, reducing the cost of raw materials and components for UK businesses. This can lower production costs and lead to an increase in aggregate supply.

Changes in Tax Rates

Taxation, particularly indirect taxes (such as Value Added Tax - VAT, or excise duties on products like petrol and alcohol), directly affects the cost of production for firms. Taxes on goods and services can increase the cost of production, while changes in tax policy can influence the overall supply in the economy.

• Increase in Taxes: An increase in taxes, particularly indirect taxes like VAT or business rates, raises the cost of production. Firms may respond by reducing output because they face higher costs, leading to a shift leftward of the SRAS curve. This happens because the higher costs reduce the ability or incentive for firms to supply goods and services at the same price level.
• Decrease in Taxes: A reduction in taxes, such as a cut in business rates or a reduction in VAT, lowers the cost of production for firms. This encourages firms to increase their output, leading to a shift rightward of the SRAS curve. Lower taxes improve profitability, which can incentivise firms to increase supply.

Example: If the government raises VAT on consumer goods, businesses may pass on the increased costs to consumers in the form of higher prices. As a result, demand for goods may fall, and firms may reduce output, leading to a decrease in aggregate supply.

Example: If the government reduces corporate tax rates or cuts VAT on goods, firms may face lower production costs, which could lead to increased output and higher aggregate supply.

Summary of Key Points

• Changes in the Costs of Raw Materials and Energy: An increase in the costs of raw materials or energy raises production costs, shifting the SRAS curve to the left, reducing output. A decrease in these costs reduces production costs and shifts the SRAS curve to the right, increasing output.
• Changes in Exchange Rates: A depreciation of the national currency makes imports more expensive, raising production costs and shifting the SRAS curve to the left. An appreciation of the currency makes imports cheaper, reducing production costs and shifting the SRAS curve to the right.
• Changes in Tax Rates: An increase in taxes, particularly indirect taxes, raises production costs, shifting the SRAS curve to the left. A decrease in taxes lowers production costs, shifting the SRAS curve to the right.

By understanding these factors, you can better analyse how changes in raw material costs, exchange rates, and tax policies can influence the short-run aggregate supply, impacting the economy's output and overall economic performance.