Short Run Aggregate Supply - Online Tutor, Practice Problems & Exam Prep

In the short run, the short-run aggregate supply (SRAS) curve slopes upward, indicating that higher price levels lead to increased production of goods and services. This phenomenon is explained by three theories: the sticky wage theory, where wages do not rise as quickly as prices, leading to higher profits and output; the sticky price theory, where some prices remain fixed due to menu costs, attracting more business; and the misperceptions theory, where businesses mistakenly interpret rising prices as a signal to increase output. Understanding these concepts is crucial for analyzing macroeconomic conditions.

SRAS

Alright. So we've seen aggregate supply in the long run. Now, let's check it out in the short run. So we're still in this ADAS model. Right? Aggregate demand and aggregate supply. Well, when we talk about aggregate supply, right, we had the long run aggregate supply that was that straight up and down curve. But the short run aggregate supply is going to look a little more familiar to what we studied with our market supplies. So in the short run, well, the quantity of real GDP is affected by current price levels. Remember in the long run, we said that it had to do with the factors of production. How much labor we had in our economy? How much capital? How much we had available to produce stuff? And in the long run, well, that was going to be capped out at that amount. But in the short run, well, the prices are going to affect how much is going to be produced. So real GDP, remember, is goods and services produced. When we say real, we're not really thinking about the prices there, but the amount that's being produced. So in the short run, the price is going to affect the amount being produced. Alright?

So in the short run, an increase in the price level will lead to an increase in production of goods and vice versa, right? A decrease in the price level will lead to a decrease of the production of goods. Alright? So here, we're going to draw our short run It just went like this. Right? It started down here and as the price went up, it just went like this. Right? It started down here and as the price went up, we supplied more. Right? Higher prices, more supply. Well, the same thing's going to happen here in the short run. The price level, remember when we're talking about aggregate supply, well, we're now including all goods and services in the economy. So the price level of goods and services is going to be our axis there. And GDP. We're talking about real GDP here. So a quantity of goods and services is being provided in the economy. So here we go. We've got our short run and supply and supply, right? So let's go ahead and pause here and in the next video, let's discuss why the aggregate supply Remember, now we have to think about macroeconomic conditions that lead us to having this type of curve in the short run. Okay?

So what does it tell us? Well, remember, at a low price level, that means in the short run, we're going to have a lower GDP at some low price level. We'll say low here compared to up here. Right? If there's some higher price level, we're going to have some higher GDP. GDP high, GDP low, price high, price level high, right? So something like what we're used to in market supply and demand. Alright? So let's pause real quick and let's talk why this is the case.

SRAS Slopes Upwards

So there's three theories that come into play when we think about why the short-run aggregate supply curve tends to have this upward slope like we see in our graph. Okay? So some of these might be a little contradictory, but the idea is that they all tend to show why the short run would go up as the price level goes up. So let's think about the first one here, the sticky wage theory. Sticky, remember when we talked about sticky versus flexible? Sticky means more or less fixed. Right? That the wages are going to be more fixed. So sticky wage theory says that wages do not increase as quickly as the price level. So what we're going to see is the prices going up during an economic boom, but the wages don't increase as quickly, right? You don't see that your boss, you work at a coffee shop or something and the prices are going up and they're like, hey, we're charging more. Here, take more money as well. Usually, the wages don't go up as fast as the price level goes up. So what does that do for profit? If we see this selling price going up, but this wage, right? The cost of running the restaurant or running your business stays equal, well, the selling price is going up. The cost is staying the same so there's going to be more profit, right? The profit is going to be going up as well. So what does that tell us? That they're going to want to supply more, right? As those price levels go up, they're going to want to supply more because their costs are staying relatively stable while their prices are going up, so they're going to want to supply more.

Another example of why these wages are sticky is union wages. Unions usually set their wages in a contract and it's going to be fixed over several years. So if the economy starts to boom, well, those wages are fixed and they're not going to boom as well. Alright? So that's the sticky wage theory.

How about the sticky price theory? So this one kind of contradicts in the way that now we're saying that some prices do not increase in line with the price level. So now, we're saying that some of the prices aren't going up as quickly. So the sticky wage theory is saying that wages don't go up as quickly. The sticky price theory is saying some prices don't seem to go up as quickly and that's because of this idea of menu costs. We might have talked about this before but the idea of menu costs is a cost businesses face from changing prices. And the illusion here is to a restaurant having to print a new menu and the cost of printing a new menu when they're changing their prices. If they want to have higher prices, they're going to have to change the menu, reprint everything, right? So, that's going to cost them money. So maybe some restaurants would say, hey, I'd rather just keep the same menu so I don't have to put in all that money to change, to change what our money looks like.

So how does the sticky price theory relate to this short-run aggregate supply having that upward curve? Well, if those price levels do not go up so in this example of the restaurant that doesn't increase its prices, well, that restaurant's going to have lower prices compared to other places, right? And it's going to increase their sales quantity which leads to higher output, right? So at those higher price levels in the economy, these places that didn't raise their prices, even though the economy-wide prices have gone up, well, they're going to see more business and they're going to have to produce more to keep up with that higher level of business, right? When they when people go to their cheaper restaurant, right? So the sticky wage theory, sticky price theory, they both show us how, as the price level goes up, the quantity goes up, right? The quantity that's going to be supplied.

And finally, we have the misperceptions theory. I say the two most important are these two. They seem to come up the most. But misperceptions theory just It's kind of that when businesses see general price levels increase, they respond with increased output. They say, hey, the prices are going up. That's good for us. Let's produce more, right? So that's kind of a misperception that they just see higher prices and they just decide to produce more. Okay? So sticky wage theory, wages are staying fixed. Sticky price theory, some prices are staying fixed leading to more business coming in because of the lower perceived prices that they have. And misperceptions theory, people just say, hey, higher prices. Let's produce more. Cool? Alright. Let's pause here and move on to the next

Here’s what students ask on this topic:

What is the short-run aggregate supply (SRAS) curve?

The short-run aggregate supply (SRAS) curve represents the relationship between the price level and the quantity of goods and services that firms are willing to produce in the short run. Unlike the long-run aggregate supply (LRAS) curve, which is vertical, the SRAS curve slopes upward. This indicates that as the price level increases, the quantity of goods and services produced also increases. This upward slope is due to factors such as sticky wages, sticky prices, and misperceptions about price changes. Understanding the SRAS curve is crucial for analyzing how economies respond to changes in price levels in the short run.

Why does the short-run aggregate supply curve slope upward?

The short-run aggregate supply (SRAS) curve slopes upward due to three main theories: sticky wage theory, sticky price theory, and misperceptions theory. The sticky wage theory suggests that wages do not rise as quickly as prices, leading to higher profits and increased output. The sticky price theory posits that some prices remain fixed due to menu costs, attracting more business and increasing output. The misperceptions theory indicates that businesses may mistakenly interpret rising prices as a signal to increase production. These factors collectively explain why higher price levels lead to increased production in the short run.

What is the sticky wage theory in the context of short-run aggregate supply?

The sticky wage theory in the context of short-run aggregate supply (SRAS) suggests that wages do not adjust as quickly as prices. During an economic boom, prices for goods and services may rise, but wages remain relatively fixed due to contracts or slow adjustments. This lag in wage adjustment means that firms experience higher profits as their costs (wages) stay the same while their revenues (prices) increase. Consequently, firms are incentivized to produce more, leading to an upward-sloping SRAS curve. This theory helps explain why higher price levels result in increased production in the short run.

How does the sticky price theory affect short-run aggregate supply?

The sticky price theory affects short-run aggregate supply (SRAS) by suggesting that some prices do not adjust as quickly as the overall price level due to menu costs. Menu costs refer to the expenses associated with changing prices, such as printing new menus in a restaurant. When some firms keep their prices fixed while the general price level rises, they attract more customers due to their relatively lower prices. This increased demand leads to higher output. As a result, the SRAS curve slopes upward, indicating that higher price levels lead to increased production in the short run.

What is the misperceptions theory in relation to short-run aggregate supply?

The misperceptions theory in relation to short-run aggregate supply (SRAS) suggests that businesses may mistakenly interpret rising prices as a signal to increase production. When general price levels increase, firms might perceive this as an opportunity for higher profits and thus ramp up their output. This misperception leads to an increase in the quantity of goods and services produced, contributing to the upward slope of the SRAS curve. The theory highlights how incorrect interpretations of price changes can influence production decisions in the short run.