Aggregate supply is the other half of the model. It answers a different question from AD: not how much the economy wants to buy, but how much firms are willing to produce. In the short run that depends on prices and costs, and the gap between those two is what makes the curve slope upwards.
📘 What you need to know
Aggregate supply is the total output firms are willing to produce at each average price level.
The short run is the period in which wages and other factor prices are inflexible, so they do not adjust straight away.
The long run is the period in which wages and factor prices are fully flexible.
The SRAS curve slopes upwards, because with costs fixed, a higher price level makes extra output more profitable.
A change in the average price level causes a movement along SRAS.
SRAS shifts when costs of production or indirect taxes change.
A shift in SRAS does not change the economy’s potential output. Only long-run supply does that.
Why SRAS slopes upwards
The whole explanation hangs on one word: sticky. In the short run, wages are fixed by contracts, rents are fixed by leases, and many input prices are agreed in advance. Firms cannot change these overnight even if they want to.
Now suppose the average price level rises. The firm can sell its output for more, but its wage bill and rent have not changed. The profit on each extra unit is bigger, so producing more becomes worthwhile: overtime is authorised, extra shifts are added, older equipment is brought back into use.
There is a second, simpler reason too. Aggregate supply is the sum of every individual firm’s supply curve, and individual supply curves slope upwards. Adding up a lot of upward sloping curves gives you an upward sloping curve.
The curve has not moved. A change in the average price level simply takes the economy to a different point on the same curve.
Price level rises from AP1 to AP2: movement from A to B and an expansion of output from Y1 to Y2.
Price level falls from AP1 to AP3: movement from A to C and a contraction from Y1 to Y3.
Notice how neatly the short run and long run are defined here. They are not lengths of time. The short run is defined by wages being stuck, and the long run by wages being free to move. That definition is what makes the classical self-correction story work later in this topic, so it is worth memorising word for word.
What shifts SRAS
Only two things at SL, and both are about costs of production.
At the same price level AP1, firms are willing to supply Y3, Y1 or Y2 depending on what their costs are.
Change
Why it happens
Effect on SRAS
Input costs rise
Oil, energy, raw materials, wages, imported components. Each unit now costs more to make, so less can be produced for the same money.
SRAS shifts left
Input costs fall
Cheaper energy, lower wage settlements, a stronger currency making imported inputs cheaper.
SRAS shifts right
Indirect taxes rise
An indirect tax is an extra cost per unit for firms, exactly as it is in a microeconomics diagram.
SRAS shifts left
Indirect taxes fall, or subsidies rise
Costs per unit come down, so firms supply more at every price level.
SRAS shifts right
Several things sit behind those input costs, and being able to name them is useful in a data question: wage rates, interest rates (firms borrow to fund operations), government regulation (compliance costs money), and exchange rates (which decide what imported inputs cost).
The exchange rate cuts both ways. A depreciation raises net exports, which shifts AD right. It also makes imported oil, components and machinery more expensive, which shifts SRAS left. That combination raises the price level twice over, and spotting it is a strong analytical point.
The distinction that earns marks
SRAS and long-run aggregate supply are different things, and mixing them up is the most expensive error in this sub-topic.
Question
SRAS
LRAS
What moves it?
Costs of production and indirect taxes
The quantity or quality of the factors of production
Does potential output change?
No
Yes
How long does it last?
Until wages and other costs adjust
It is the new long-run position
Example
A spike in world oil prices
A better educated workforce, or new infrastructure
The test is simple. Ask yourself: has the economy’s capacity changed, or just what it costs to use that capacity? An oil price spike does not destroy a single factory. It just makes running them dearer. So it is SRAS. Training a million workers genuinely raises what the economy can produce. That is LRAS.
WORKED EXAMPLE
World oil prices double. Explain the effect on short-run aggregate supply and on the macroeconomic equilibrium. [4]
Step 1: identify what changedOil is an input for transport, energy and manufacturing, so this is a rise in costs of production, not a price level change.Step 2: direction of the shiftcosts up, so firms supply less at every price level: SRAS shifts leftStep 3: the new equilibriumAD is unchanged, so it now meets SRAS at a higher price level and lower real GDPInflation rises while output falls: cost-push inflationThis combination is uncomfortable precisely because demand-side policy cannot fix both problems at once.
WORKED EXAMPLE
For each of the following, state whether SRAS or LRAS is affected and in which direction: (a) a rise in VAT, (b) large scale investment in worker training, (c) a fall in the price of imported steel. [3]
(a) a rise in VATAn indirect tax is an extra cost per unit. Capacity is unchanged.SRAS shifts left(b) investment in worker trainingthe quality of labour improves, so the economy can produce moreLRAS shifts right(c) cheaper imported steela fall in input costs, with no change in capacitySRAS shifts rightAsk the capacity question every time and these become easy marks.
💡 Exam tip
Define the short run properly: the period in which wages and other factor prices are inflexible. It is a definition mark.
Give both reasons for the upward slope if a question asks why. Sticky costs, and the sum of individual supply curves.
Say “at every price level” when you describe a shift. It is the phrase that shows you understand the difference from a movement.
Link SRAS shifts to cost-push inflation. Leftward SRAS gives higher prices and lower output at the same time.
Check whether capacity changed before deciding between SRAS and LRAS.
Label SRAS1 and SRAS2 with an arrow showing the direction of the shift.
⚠️ Common mix-up
Shifting SRAS when the price level changes. That is a movement along, exactly as with AD.
Thinking higher costs shift SRAS right. Higher costs mean less output at every price level, so the curve moves left.
Confusing an SRAS shift with a change in potential output. Costs changing is not the same as capacity changing.
Treating the short run as a fixed number of months. It is defined by wage flexibility, not by the calendar.
Forgetting indirect taxes. They are one of only two SRAS determinants at SL, and they get overlooked.
Ignoring the AD side of an exchange rate change. A depreciation moves both curves, and a strong answer says so.
Up next: The Monetarist and Keynesian Views of Supply, where economists stop agreeing and the shape of the long-run curve becomes an argument.
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