Updated: Oct 23, 2018
Effects on Aggregate Supply in the Short Run
The economy’s aggregate supply is affected by tariffs both directly and indirectly.
Although the producers in an economy may be domestic businesses, they likely use some foreign components in their production process. Tariffs on imported goods that are used as inputs in domestic production processes raise the cost of production. When producing goods and services costs more, there will be less production than before. As this effect ripples through the economy, the aggregate supply of goods and services – which is, technically, the economy’s total production or GDP – decreases. This is their direct effect on aggregate supply.
When the supply of goods decreases, the price of those goods rises. This happens in each market affected and as it aggregates across the whole economy, it pushes up the overall price level. The direct effect of tariffs through the supply side of the economy therefore is to raise prices across the economy (“higher inflation”) and lower GDP growth.