Short-Run Aggregate Supply (SRAS) refers to the relationship between the quantity of real output supplied and the price level in the short-run, when at least one factor of production is fixed. This concept is central to understanding how the AD/AS model incorporates growth, unemployment, and inflation.
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In the short-run, the SRAS curve is upward-sloping, reflecting the law of diminishing returns, where firms can increase output by using more variable inputs like labor, but at a decreasing rate.
The SRAS curve shifts in response to changes in input prices, such as wages or the prices of raw materials, as well as changes in productivity.
An increase in input prices, such as higher wages, will cause the SRAS curve to shift to the left, leading to a higher price level and lower real output.
Improvements in productivity, such as technological advancements, will cause the SRAS curve to shift to the right, leading to a lower price level and higher real output.
The position of the SRAS curve relative to the LRAS curve determines the degree of inflationary or deflationary pressures in the economy.
Review Questions
Explain how the SRAS curve reflects the law of diminishing returns and how this affects the relationship between the quantity of real output supplied and the price level.
The SRAS curve is upward-sloping because of the law of diminishing returns. In the short-run, when at least one factor of production is fixed, firms can increase output by using more variable inputs like labor. However, as more variable inputs are added, the marginal productivity of those inputs decreases, leading to higher marginal costs for firms. Firms will then pass these higher costs on to consumers in the form of higher prices, resulting in the upward-sloping SRAS curve.
Describe how changes in input prices and productivity can shift the SRAS curve, and explain the resulting effects on the price level and real output.
An increase in input prices, such as higher wages or raw material costs, will cause the SRAS curve to shift to the left. This leads to a higher price level and lower real output, as firms must charge more to cover their increased costs. Conversely, improvements in productivity, such as technological advancements, will cause the SRAS curve to shift to the right. This results in a lower price level and higher real output, as firms can produce more with the same or fewer inputs. The position of the SRAS curve relative to the LRAS curve determines the degree of inflationary or deflationary pressures in the economy.
Analyze how the relationship between the SRAS and LRAS curves can be used to understand the incorporation of growth, unemployment, and inflation in the AD/AS model.
The relationship between the SRAS and LRAS curves is crucial for understanding how the AD/AS model incorporates growth, unemployment, and inflation. In the long-run, the LRAS curve represents the economy's potential output, which is determined by factors such as the labor force, capital stock, and technology. The position of the SRAS curve relative to the LRAS curve indicates the degree of inflationary or deflationary pressures in the economy. If the SRAS curve is below the LRAS curve, there is a recessionary gap, leading to higher unemployment and lower inflation. Conversely, if the SRAS curve is above the LRAS curve, there is an inflationary gap, resulting in higher inflation and lower unemployment. Understanding these relationships is crucial for policymakers to implement appropriate measures to promote economic growth, reduce unemployment, and maintain price stability.