Determinants of Aggregate Supply
What is Determinants of Aggregate Supply?
The determinants of aggregate supply are non-price factors, input prices, productivity, taxes/subsidies on producers, and expectations, that shift the SRAS curve.
SRAS shifts when something other than the price level changes firms' per-unit production costs. Falling input/resource prices (e.g., cheaper oil or lower nominal wages) and rising productivity shift SRAS right, lowering the price level and raising output; supply shocks like a spike in energy prices shift it left, causing cost-push inflation. Business taxes and regulation also shift SRAS, while changes that raise the economy's productive capacity shift both SRAS and LRAS. Distinguish a shift of SRAS (a determinant changed) from a movement along it (the price level changed).
Determinants of Aggregate Supply: a worked example
Suppose a representative firm needs 2 labor hours at $25 plus one unit of raw material at $30 to make a unit of output. Unit cost is $50 + $30 = $80, and at a standard 25 percent markup the firm posts $100. With the price level at its starting value, firms across the economy supply 500 units. Now a supply shock pushes the raw material to $50. Unit cost becomes $50 + $50 = $100, the same markup now requires $125, and at the unchanged price level firms supply fewer than 500 units, so SRAS has shifted left. Reverse it with a productivity gain: better training cuts labor to 1.6 hours, so labor cost falls to 1.6 × $25 = $40, unit cost falls to $70, and the markup price drops to $87.50. At that same unchanged price level, firms now willingly supply 560 units, an SRAS shift right.
The mistake students make with determinants of aggregate supply
The word 'taxes' does most of the damage here. Students shift SRAS for any tax change, so a cut in personal income taxes gets drawn as a rightward SRAS shift when it belongs on aggregate demand. Sort by asking whose per-unit production cost changed. A cut in business taxes or a per-unit producer subsidy lowers firms' costs and shifts SRAS right, while a cut in household income taxes raises disposable income and shifts AD right. The same test separates a fuel subsidy paid to manufacturers, which moves SRAS, from a rebate mailed to households, which moves AD.
Determinants of Aggregate Supply questions
What causes the short-run aggregate supply curve to shift?
Changes in per-unit production costs that have nothing to do with the price level. Input and resource prices, nominal wages, productivity, business taxes and subsidies, regulation, and expectations about future inflation all qualify. Falling input prices or rising productivity shift SRAS right, raising real output and easing the price level. A cost shock such as an energy price spike shifts SRAS left, delivering a higher price level with lower output, the pattern called stagflation.
Do higher wages shift SRAS to the left?
Higher nominal wages raise per-unit labor cost, so SRAS shifts left, the price level rises, and real output falls. The key word is nominal. A wage increase that comes from workers becoming more productive does not raise cost per unit, since each worker now produces more, so SRAS need not move. Exam prompts usually specify a wage rise driven by contracts or by higher expected inflation, which is the leftward-shift case.
What is the difference between an SRAS shift and an LRAS shift?
SRAS moves when per-unit production costs change, including temporary changes such as an energy price spike that later reverses. LRAS moves only when the economy's productive capacity changes, through more capital, a larger or better-trained labor force, improved technology, or newly available resources. Some events move both, since a permanent productivity gain lowers costs today and raises potential output. A one-off input price shock moves SRAS alone and leaves LRAS exactly where it was.
This is the live AD/AS Model sandbox. Drag the curves, or open the full version.
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