Why Does the Short-Run Aggregate Supply Curve Slope Upward?
Uncover the foundational reasons behind the positive relationship between price levels and national output in macroeconomic models.
The aggregate supply curve illustrates the total quantity of goods and services that firms are willing and able to produce and sell at various price levels. In macroeconomics, this relationship is often divided into short-run and long-run perspectives. The short-run aggregate supply (SRAS) curve, a central concept in this analysis, depicts a positive relationship between the overall price level and the quantity of aggregate output supplied.
Characteristics of the Short Run
The short run in economics is not defined by a specific period of time, but rather by the presence of at least one fixed factor of production. During this period, businesses operate under constraints where some input costs, like wages or existing capital, are fixed or slow to adjust.
Capital, such as factories and machinery, often represents a fixed input in the short run because it takes time and significant investment to expand or reduce these assets. Consequently, firms primarily adjust their output by changing variable inputs like labor and raw materials. While output prices can fluctuate, the rigidity of some input prices creates a dynamic where production decisions are influenced by how these fixed costs interact with changing market prices.
The Role of Sticky Wages
One primary explanation for the upward slope of the SRAS curve involves the concept of “sticky wages.” This theory posits that nominal wages adjust slowly to changes in economic conditions. This stickiness can arise from various factors, including long-term employment contracts, social norms, or the reluctance of employees to accept wage reductions. For instance, many employment contracts specify wages for a set period, often a year, making immediate adjustments impractical.
When the overall price level in the economy rises, but nominal wages remain fixed due to these rigidities, the real wage effectively decreases. A lower real wage means that labor becomes relatively cheaper for firms. This reduction in the real cost of labor incentivizes businesses to hire more workers and increase their production. Therefore, as the price level increases, firms find it more profitable to expand output.
The Impact of Sticky Prices
Another contributing factor to the upward-sloping SRAS curve is the phenomenon of “sticky prices.” This refers to the resistance of some product prices to change quickly. Businesses face various costs associated with changing their prices, known as “menu costs,” which include the physical cost of printing new menus or catalogs, as well as the time and effort involved in analyzing market conditions and implementing new pricing strategies.
Beyond menu costs, firms might also hesitate to adjust prices due to concerns about customer relationships or potential competitive reactions. If the overall price level rises, but a firm’s prices remain temporarily unchanged, its products become relatively cheaper compared to others. To avoid losing market share or to capitalize on increased demand, such firms may opt to increase their production levels to meet the new demand at their existing, temporarily sticky prices. This behavior, where firms adjust quantities produced rather than immediately changing prices, contributes to the upward slope.
The Influence of Misperceptions
The “misperceptions theory” offers a psychological explanation for the upward-sloping SRAS curve. This theory suggests that individual firms and workers may sometimes confuse a change in the general price level with a change in the relative price of their specific output or labor. For example, if the overall price level in the economy rises, a producer might observe an increase in the price of their own product.
The producer may mistakenly interpret this individual price increase as a signal of higher demand for their specific good, rather than recognizing it as part of a broader inflationary trend affecting all prices. Believing that the relative profitability of their product has increased, they are then incentivized to expand production. Similarly, workers might misinterpret a rise in their nominal wages as an increase in their real wages, leading them to supply more labor. These misperceptions lead to an increase in aggregate output when the price level rises.