Short-Run Aggregate Supply (SRAS) refers to the total output of goods and services that producers are willing and able to supply in the short term at different price levels, assuming some input prices remain fixed.
What is Short-Run Aggregate Supply?
Short-run aggregate supply (SRAS) represents the quantity of real output that firms in an economy are willing to produce at various price levels in the short term, holding input costs (like wages, rent, and raw materials) constant. In this context, the "short run" is defined as the period during which at least one factor of production—usually wages—is fixed.
In the short run, firms respond to rising prices by increasing output to boost profits, assuming their production costs do not increase proportionally. This creates the typical upward-sloping shape of the SRAS curve. It reflects a positive relationship between the general price level and the quantity of goods and services supplied.
When the price level rises, firms find it more profitable to increase production, as they can sell goods at higher prices while wages and other costs remain constant.
When the price level falls, profits shrink and firms may reduce output accordingly.
This behaviour underpins the short-run supply response and forms the basis of short-run aggregate supply analysis in macroeconomics.
Factors That Influence Short-Run Aggregate Supply
Several key factors can cause the SRAS curve to shift. These include changes in input costs, exchange rates, and taxation. A rightward shift of the SRAS curve means that firms are willing to supply more output at each price level, whereas a leftward shift implies reduced willingness or ability to supply goods and services.
1. Changes in the Cost of Raw Materials and Energy
The cost of raw materials and energy has a direct impact on the cost of production for businesses. These inputs are fundamental to nearly every productive process in the economy, whether in manufacturing, construction, agriculture, or services.
Rising input costs increase firms' overall cost structure. When energy prices such as oil or gas increase, transport and utility expenses rise. Similarly, when raw materials like steel, copper, or food commodities become more expensive, the cost of producing goods rises.
As a result, firms may scale back production to maintain profitability, leading to a leftward shift of the SRAS curve.
This is often seen during supply-side shocks, such as oil crises or geopolitical disruptions to commodity supply chains.
Falling input costs reduce the marginal cost of production. If energy becomes cheaper due to technological advances or supply abundance, firms can increase output without a proportional rise in costs.
This results in a rightward shift of the SRAS curve, increasing short-run output at every price level.
Example: A fall in global oil prices due to increased shale oil production in the US can reduce transportation and production costs for UK businesses, encouraging a rise in short-run output.
Diagram tip: Show an initial SRAS curve (labelled SRAS1) shifting to the right (to SRAS2) in response to falling energy prices, demonstrating the increase in output and resulting downward pressure on the price level.
2. Changes in Exchange Rates
Exchange rate movements influence the domestic price of imported goods and inputs, which are vital for many industries. The UK, in particular, imports a significant proportion of raw materials, semi-finished goods, and capital equipment.
An appreciation of the domestic currency (e.g. the British pound becomes stronger against the US dollar or the euro):
Makes imports cheaper, reducing the cost of imported components, raw materials, and equipment.
This lowers input costs, allowing firms to produce more for the same level of expenditure.
Leads to a rightward shift in the SRAS curve.
A depreciation of the domestic currency (e.g. the pound weakens):
Makes imports more expensive, raising input costs for firms reliant on imported goods.
Profit margins decline unless prices are increased, discouraging production.
Causes a leftward shift in the SRAS curve.
Example: After the 2016 EU referendum, the pound fell sharply against major currencies. This led to increased costs for UK firms importing goods and raw materials, reducing SRAS as businesses faced tighter margins.
Sectoral impact: Exchange rate movements have a larger effect on import-intensive industries, such as automotive manufacturing, electronics, and food processing. These sectors rely heavily on global supply chains, making them highly sensitive to currency volatility.
Diagram tip: Illustrate a leftward shift in SRAS due to a depreciation of the currency, increasing the domestic price of imports and reducing output at each price level.
3. Changes in Tax Rates
The tax system also affects short-run aggregate supply through its influence on production costs and profitability.
Increased taxes—especially those levied on production, such as corporate taxes, National Insurance contributions, or environmental levies—raise firms’ operating costs.
Firms may cut output, delay investment, or increase prices.
This leads to a leftward shift of the SRAS curve as businesses reduce short-run supply.
Reduced taxes lower firms’ costs and improve after-tax profitability.
Encourages expansion in output and possibly greater employment.
This causes a rightward shift in the SRAS curve.
Example: A government policy to reduce employer National Insurance contributions by 2 percentage points lowers the cost of hiring workers. As a result, service-sector firms may expand operations and increase output.
Note: Taxes that affect consumption (such as VAT) may also indirectly impact SRAS if they change demand conditions, though their primary effect is on the aggregate demand side.
Short-run vs long-run tax effects: The impact of tax changes on SRAS tends to be more immediate than on LRAS, as it directly influences business decisions in the current production cycle.
Evaluating the Responsiveness of SRAS
While the above factors can clearly shift SRAS, the degree of responsiveness varies depending on the sector, economic climate, and nature of the change. This responsiveness is also known as elasticity of SRAS.
Sectoral Differences
Different industries react differently to the same cost shocks depending on their input structure and operating flexibility.
Energy-intensive sectors (e.g. steel, cement, chemicals):
Highly responsive to changes in energy prices.
An increase in fuel or electricity costs can lead to significant reductions in output, shifting SRAS leftward sharply.
Labour-intensive sectors (e.g. hospitality, care work, education):
More sensitive to wage costs and employment taxes than raw materials.
A hike in the minimum wage or employer contributions can reduce short-run supply, especially in sectors with low-profit margins.
Import-dependent sectors (e.g. automotive, clothing, electronics):
Strongly affected by exchange rate movements.
Currency depreciation may have a pronounced impact on SRAS due to reliance on imported components.
Capital-intensive sectors (e.g. pharmaceuticals, aerospace):
May be less immediately responsive to input cost changes due to long production cycles, contracts, or regulatory constraints.
Nature and Duration of Cost Changes
Temporary vs permanent shocks:
Temporary rises in costs may have limited impact if firms expect prices to normalise soon.
Long-term cost increases force structural adjustments (e.g. cutting output, raising prices), resulting in greater shifts in SRAS.
Predictability:
Sudden or unexpected increases in costs (e.g. due to war or natural disaster) lead to more disruptive changes in SRAS.
Predictable or gradual changes (e.g. phased tax reforms) allow businesses to plan and mitigate the impact.
Broader Economic Conditions
In periods of economic expansion, firms may be more willing to absorb modest cost increases to meet rising demand, reducing the shift in SRAS.
During a recession or high uncertainty, even small cost increases may result in disproportionate reductions in output, as firms are already operating close to survival margins.
Business confidence plays a significant role in how aggressively firms respond to cost changes. Higher confidence encourages investment and output expansion, even if costs rise modestly.
Adjustment Lags and Flexibility
The speed at which firms can adjust also influences SRAS responsiveness.
Firms with flexible production lines or variable contracts can respond quickly to changing conditions.
Firms with rigid cost structures or long-term supply contracts may adjust more slowly, muting the SRAS response.
Timeframe considerations:
In the very short run, output changes are limited by existing capacity and inventory.
Over a few months, firms may scale output by adjusting hours, hiring, or sourcing alternative inputs.
Policy Context
Government policies, such as subsidies, price controls, or supply-side reforms, can influence how firms respond to changes in costs.
In some cases, policy can offset negative supply shocks, for example, by offering temporary tax relief or grants for energy costs.
Diagram tip for evaluation: Use multiple SRAS curves to show differing shifts across sectors or economic conditions. For instance, SRAS shifting more for energy-intensive sectors compared to service sectors under the same cost increase.
FAQ
The SRAS curve is upward-sloping because, in the short run, some input prices—especially wages—are fixed or sticky, while output prices can vary more freely. When the general price level rises, firms receive more revenue for their goods and services, but their immediate costs remain relatively stable. This increases their profit margins and provides an incentive to expand output. However, as production increases, diminishing marginal returns to variable factors (such as labour or energy) begin to set in. Firms may need to pay overtime wages, operate machinery for longer hours, or use less efficient resources, all of which increase marginal costs. Therefore, while firms are willing to produce more as prices rise, the cost of doing so also rises incrementally, giving the curve its upward slope. It is not vertical because input prices haven’t adjusted fully, and not horizontal because higher output comes at a higher marginal cost in the short run.
Supply shocks directly affect the SRAS curve by altering the cost or availability of inputs, while demand shocks influence aggregate demand and typically result in movement along the SRAS curve. A negative supply shock—such as a sudden spike in oil prices or a natural disaster disrupting production—raises firms’ costs or reduces their productive capacity. This causes the SRAS curve to shift to the left, leading to lower output and higher prices (cost-push inflation). A positive supply shock, like a sudden drop in commodity prices or improved access to key inputs, shifts SRAS to the right, reducing inflationary pressure and increasing output. In contrast, a demand shock changes the level of spending in the economy, causing movement along the existing SRAS curve. For instance, if consumer demand increases, firms will produce more along the SRAS curve, but costs may rise if they operate closer to full capacity. Thus, only supply shocks shift SRAS.
Wage agreements and fixed contracts are central to the short-run nature of SRAS. In the short run, many workers are on fixed-wage contracts—often negotiated annually or for even longer durations—which means firms cannot immediately adjust wages in response to changes in economic conditions. This wage stickiness means that when the price level changes, labour costs remain constant temporarily, allowing firms to adjust output without a proportionate change in total costs. For example, if prices rise and wages are fixed, profit margins improve, and firms are incentivised to increase output, shifting along the SRAS curve. However, if wages are renegotiated or index-linked to inflation, input costs could rise faster, making SRAS more inelastic and limiting the firm's ability to respond. Additionally, multi-year procurement or supplier contracts fix other costs like materials or services, reinforcing this rigidity. These fixed agreements help define the "short run" period and determine the responsiveness of supply to economic shocks.
Yes, government subsidies can directly influence SRAS by altering the effective cost of production for firms. A subsidy is a financial grant from the government to reduce firms’ operating expenses, often aimed at encouraging production in a specific sector or industry. When firms receive subsidies—such as energy cost relief, wage subsidies, or R&D support—their marginal costs fall, improving profitability. This encourages higher levels of output at every price level, resulting in a rightward shift of the SRAS curve. For example, a temporary fuel subsidy for transport companies during an oil price spike could allow firms to maintain or even increase supply without passing costs onto consumers. On the other hand, if a subsidy is removed or reduced, the reverse effect occurs: costs rise, profits decline, and SRAS may shift leftward. Importantly, while subsidies can improve short-run supply conditions, they may also have long-term budgetary implications and risk distorting market incentives if misused.
Supply chain disruptions can significantly reduce SRAS even when domestic input prices remain unchanged. Disruptions—caused by events like port closures, geopolitical conflict, pandemics, or natural disasters—affect the availability and timing of critical inputs, not just their price. If firms cannot access essential materials or intermediate goods when needed, production slows or halts entirely, regardless of cost. This lowers total output capacity in the short run and shifts the SRAS curve to the left. For example, a shortage of semiconductors due to overseas factory shutdowns can cripple automobile production in the UK, even if labour and energy costs are steady. Moreover, uncertainty about future supply can lead firms to delay production or investment decisions. Bottlenecks and delays in the supply chain may also force companies to use more expensive or lower-quality substitutes, increasing unit costs and reducing efficiency. Thus, the physical availability of inputs is just as important as their price in determining SRAS.
Practice Questions
Explain how a rise in energy prices might affect short-run aggregate supply in the UK economy.
A rise in energy prices increases firms’ production costs, particularly in energy-intensive industries such as manufacturing and transport. As costs rise, profit margins shrink, reducing firms' willingness and ability to supply the same level of output at existing prices. This causes the short-run aggregate supply (SRAS) curve to shift leftward. As a result, the economy may experience higher prices (cost-push inflation) and lower real output in the short term. The extent of the impact depends on how reliant sectors are on energy and whether firms can absorb costs or pass them on to consumers through price increases.
Analyse how a depreciation in the exchange rate might affect the short-run aggregate supply of the UK economy.
A depreciation in the exchange rate makes imported goods and raw materials more expensive. For UK firms that rely on imports—such as components, energy, or capital equipment—this increases production costs. As input prices rise, firms are likely to reduce output unless they can pass on the costs to consumers, leading to a leftward shift in the SRAS curve. The scale of the impact depends on the elasticity of demand, the share of imported inputs, and whether firms have access to domestic alternatives. In sectors heavily dependent on imports, this can reduce competitiveness and amplify inflationary pressures.
