3.2.2.5 - Short-run aggregate supply

Selling prices and sticky costs

Short-run aggregate supply (SRAS) is the real output firms are willing to produce at each price level while some input prices, expectations and contracts have not fully adjusted. The short run is defined by these adjustment constraints, not a fixed number of months.

Suppose selling prices rise while money wages and other input prices initially remain unchanged. Revenue per unit increases relative to cost, making additional production more profitable. Firms can use machines for longer hours, recruit labour or increase overtime, though the additional units may have higher marginal costs. Across firms, this gives an upward-sloping SRAS curve. Lower selling prices relative to sticky costs tend to reduce output supplied.

The aggregate price level is on the vertical axis, so a change in that variable alone gives a movement along SRAS. A change in production costs gives a different output supplied at every price level and therefore a shift. If selling prices and every input cost rose together proportionately, the initial profitability argument would not work in the same way. The unchanged-cost assumption is doing real work.

Costs that shift SRAS

Higher costs tend to shift SRAS left/up: firms require a higher selling-price level to supply a given amount, or supply less at a given price level. Lower costs tend to shift it right/down. The main determinants work through unit production costs.

Distinguish a tax that directly affects marginal production costs from a tax on profits: a profit-tax change can affect incentives and investment, but need not produce the same immediate cost shift. State the relevant channel rather than treating all business taxes as identical.

An exchange-rate depreciation can raise the domestic-currency price of imported materials even if their foreign price is unchanged. Its net-export AD effect is a separate channel. A world commodity-price fall can lower costs across many firms; its effect depends on how heavily they use that commodity and on hedging or contracts that delay price transmission.

Money wages alone are insufficient to diagnose costs. A 5% pay rise accompanied by a larger productivity rise need not increase unit labour costs. Conversely, unchanged pay with falling productivity can raise labour cost per unit. Other input costs still matter, so a labour-cost calculation cannot establish the entire economy's supply position by itself.