Question

Determine the effect on short-run aggregate supply for each of the following events. Explain whether it represents a movement along the SRAS curve or a shift of the SRAS curve.

a. A rise in the consumer price index (CPI) leads producers to increase output.

b. A fall in the price of oil leads producers to increase output.

c. A rise in legally mandated retirement benefits paid to workers leads producers to reduce output.

Short answer

1. A rise in the CPI indicates a movement along the SRAS curve as the producers increase aggregate output, owing to the high prices of consumer products.
2. When oil prices decline and the producers increase output, it indicates an aggregate supply curve shift due to lower production costs.
3. Mandatory retirement benefits increase will lead to a shift of the SRAS as the cost of hiring labor increases.

Step-by-step solution

Examining the SRAS adjustments due to a rise in the CPI

The consumer price index (CPI) is used to measure inflation by computing the changes in the price of consumer products in an economy.

When the CPI increases, it indicates a rise in the price level of consumer goods. An increase in the price level denotes an upward movement along the SRAS curve corresponding to a higher level of equilibrium aggregate output.

Examining the SRAS adjustments due to a fall in the price of oil

If the oil price were to fall, a movement along the SRAS curve would lead to higher output.

However, as the output increased, it denoted a shift of the SRAS curve. The reason for a simultaneous fall in price and output increase can be the lower cost of production.

If the production cost of oil reduces, the supply curve will shift rightwards as producers can sell a higher quantity at every price level. Thus, the market price per unit would reduce, and the overall units produced in the economy would also increase because the profitability of producing oil has increased.

Examining the SRAS adjustments due to a rise in retirement benefits

When producers are mandatorily required to increase the retirement benefits to the laborers, the factor cost of hiring labor increases.

The increase in the labor cost will disincentivize producers from supplying more. Thus, there will be a leftward shift of the SRAS curve because producers will choose to produce less at every price level to retain the earlier profitability.

There will be no movement along the SRAS curve because the price level remains unchanged and only the nominal wage changes.