Study Notes
2.3.2 Short-Run Aggregate Supply
- Level:
- A-Level
- Board:
- Edexcel
Last updated 9 Jul 2024
This study note for Edexcel economics covers Short-Run Aggregate Supply
1. Changes in Costs of Raw Materials and Energy
- Explanation:
- Changes in the costs of raw materials and energy directly affect production costs for firms.
- Higher costs increase the overall cost of production, shifting the SRAS curve to the left.
- Lower costs decrease production costs, shifting the SRAS curve to the right.
- Impact on SRAS:
- Increase in Costs:
- Example: A rise in oil prices increases transportation and production costs across industries.
- Result: Firms reduce output at existing price levels, shifting the SRAS curve leftward.
- Decrease in Costs:
- Example: A significant discovery of natural resources, such as shale gas, lowers energy costs.
- Result: Firms can produce more at lower costs, shifting the SRAS curve rightward.
- Increase in Costs:
- Real-World Example:
- 2008 Oil Price Shock: The spike in oil prices led to increased costs for energy-dependent industries, shifting the SRAS curve leftward and contributing to global economic slowdown.
2. Changes in Exchange Rates
- Explanation:
- Exchange rates influence the cost of imported goods and services.
- A stronger domestic currency makes imports cheaper, reducing production costs.
- A weaker domestic currency makes imports more expensive, increasing production costs.
- Impact on SRAS:
- Appreciation of Domestic Currency:
- Example: If the US dollar appreciates against the euro, the cost of importing raw materials from Europe decreases.
- Result: Lower production costs shift the SRAS curve to the right.
- Depreciation of Domestic Currency:
- Example: If the US dollar depreciates against the yen, the cost of importing components from Japan increases.
- Result: Higher production costs shift the SRAS curve to the left.
- Appreciation of Domestic Currency:
- Real-World Example:
- Post-Brexit Pound Depreciation: The depreciation of the British pound after the Brexit referendum increased import costs for UK firms, shifting the SRAS curve to the left.
3. Changes in Tax Rates
- Explanation:
- Changes in tax rates on businesses affect their cost structures and profitability.
- Higher tax rates increase costs, reducing supply.
- Lower tax rates decrease costs, increasing supply.
- Impact on SRAS:
- Increase in Tax Rates:
- Example: An increase in corporate taxes raises the cost of doing business.
- Result: Firms reduce output at existing price levels, shifting the SRAS curve leftward.
- Decrease in Tax Rates:
- Example: A reduction in payroll taxes lowers the cost of labor.
- Result: Firms can afford to produce more, shifting the SRAS curve rightward.
- Increase in Tax Rates:
- Real-World Example:
- 2018 US Tax Cuts and Jobs Act: The reduction in corporate tax rates in the US lowered production costs for businesses, contributing to a rightward shift in the SRAS curve.
Key Economists and Contributions
- John Maynard Keynes:
- Emphasized the role of aggregate demand in influencing economic output and employment.
- His analysis of sticky wages and prices helps explain why the SRAS curve slopes upward.
- Milton Friedman:
- Highlighted the importance of monetary policy and expectations in the economy.
- His work on the natural rate of unemployment informs the long-term implications of shifts in SRAS.
- Edmund Phelps:
- Developed the expectations-augmented Phillips curve, showing the relationship between inflation, unemployment, and expectations.
- His work underscores the short-term trade-offs between inflation and output.
Glossary
- Exchange Rate: The value of one currency for the purpose of conversion to another.
- Corporate Tax: A tax imposed on the net income of a company.
- Depreciation (Currency): A decrease in the value of a currency relative to other currencies.
- Appreciation (Currency): An increase in the value of a currency relative to other currencies.
- Payroll Tax: A tax imposed on employers or employees, usually calculated as a percentage of the salaries that employers pay their staff. In this UK, this is called National Insurance.
- Production Costs: The costs incurred by a business in the process of producing goods or services.
Possible Essay-Style Questions
- Analyze how a significant increase in global oil prices might affect the short-run aggregate supply curve of an oil-importing country. Use real-world examples to illustrate your points.
- Discuss the impact of a country's currency depreciation on its short-run aggregate supply. Include in your answer the effects on both import costs and domestic production.
- Evaluate the effects of a reduction in corporate tax rates on the short-run aggregate supply. How might this policy change influence economic output and employment?
- Explain the relationship between changes in raw material costs and shifts in the short-run aggregate supply curve. Provide examples of industries that might be particularly affected.
- Compare and contrast the impact of supply-side shocks versus demand-side shocks on the short-run aggregate supply curve. Use real-world examples to support your analysis.
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