Question

Briefly explain the reason for the near-vertical shape of the SRAS curve on its far right.

Short answer

The near-vertical shape of the SRAS curve on its far right is due to firms reaching their production capacity and operating at or near full employment levels. At this point, resources are fully utilized, and it becomes difficult for firms to expand their capacity further. Any attempts to increase production lead to rising input costs and higher product prices without a significant increase in output. This shows the limitations of using demand-side policies to increase short-run output when the economy is already operating at full capacity.

Step-by-step solution

1. Understanding the SRAS curve

The Short-Run Aggregate Supply curve (SRAS) shows the relationship between the price level and the quantity of goods and services firms are willing to produce in the short run. The SRAS curve is typically upward-sloping because as the price level increases, firms are more willing to produce goods and services due to higher profit margins.

2. The shape of the SRAS curve

The SRAS curve can be divided into three sections: the horizontal section, the upward-sloping section, and the vertical or near-vertical section on the far right. - Horizontal section: This section occurs at low levels of output. Here, firms have a large amount of excess capacity, and increases in demand can be met without much change in the price level. - Upward-sloping section: As output increases, firms begin to reach their capacity limits, and it becomes progressively more difficult to increase production. In response, firms raise their prices, resulting in an upward slope for the SRAS curve. - Vertical or near-vertical section: At a certain level of output, firms cannot easily expand their capacity any further, and they are producing at or near full employment levels. In this section, the SRAS curve becomes near-vertical or almost completely vertical.

3. The reason for the near-vertical SRAS curve on the far right

The near-vertical section of the SRAS curve on the far right occurs because production capacity has been reached, and firms are producing at or near their potential output. At this stage, any further increases in the price level do not lead to significant increases in production, as the resources are fully utilized, and firms face constraints in expanding their capacity further. In this near-vertical section, the economy is experiencing full employment, with little to no excess capacity. Any attempts to increase production lead to rising input costs, such as wages and raw materials, which in turn lead to higher product prices without a significant increase in output. As a result, the SRAS curve becomes increasingly steeper and eventually near-vertical. This illustrates the limitations of using demand-side policies to increase short-run output when the economy is already operating at full capacity. In conclusion, the near-vertical shape of the SRAS curve on its far right is a result of firms reaching their production capacity and operating at or near full employment levels. In this stage, any further increases in the price level do not result in significant increases in output due to the constraints faced by firms in expanding their capacity.