Short-Run and Long-Run Aggregate Supply

Short-Run Aggregate Supply

Aggregate supply (AS) shows the total real GDP that firms are willing to produce at each price level. On the graph, the vertical axis is the price level (PL) and the horizontal axis is real GDP (Y).

In the short run, the SRAS curve slopes upward. When the price level rises, firms produce more real GDP. When it falls, they produce less.

Why? Because some of a firm's costs do not adjust right away. Wages are set by contracts, union agreements, and annual salary reviews. Many other input prices, like rent and long-term supply deals, are also fixed for a while. These are called sticky wages and sticky input prices.

Suppose the prices a firm charges rise 4%, but its wage bill stays the same for now. Profit per unit goes up, so the firm hires more hours and produces more. If prices fall while wages stay fixed, profit per unit shrinks and firms cut output.

What Shifts SRAS

SRAS shifts when the cost of producing each unit of output changes at any given price level.

Rightward means more output at every price level, since costs are lower. Leftward means less output at every price level, since costs are higher.

Notice that nominal wages are an input price. If nominal wages rise across the economy, firms' costs rise and SRAS shifts left. If nominal wages fall, SRAS shifts right. Expectations work through wages: if workers expect a higher price level, they bargain for higher nominal wages, which raises costs and shifts SRAS left. If they expect a lower price level, wage demands fall and SRAS shifts right.

Long-Run Aggregate Supply

The long run is a period long enough for all wages and input prices to adjust fully. Nothing is sticky anymore. Output then depends only on the economy's real resources: the quantity and quality of labor, capital, natural resources, and technology.

So the LRAS curve is vertical at full-employment output, $Y_f$, also called potential output. Changing the price level does not change what the economy can physically produce. If prices double and every wage and input price doubles too, firms' profit per unit is the same as before, so they have no reason to change output.

What shifts LRAS? Only changes in productive capacity:

• More labor (immigration, population growth) or better-educated workers

• More physical capital (factories, machines, broadband)

• More natural resources

• Better technology that permanently raises productivity

Any of these shifts LRAS right. It also means the production possibilities curve shifts out, which is economic growth. Losing capacity, for example through a war or a disaster that destroys capital, shifts LRAS left.

Supply Shocks and Policy

A supply shock is a sudden event that shifts SRAS. Now back to the hurricane. Damaged refineries raise energy prices, so costs rise at every price level and SRAS shifts left.

In the short run, the price level rises and real GDP falls. Unemployment tends to rise as well. This combination of higher inflation and lower output is called stagflation. LRAS does not shift, since the hurricane raised energy prices but did not destroy much of the economy's capital or labor (if it did destroy a lot, LRAS would shift left too).

In the figure, the new equilibrium has a higher price level and lower real GDP. A right shift of SRAS does the opposite: a positive supply shock lowers the price level and raises real GDP.

Here is the long-run adjustment. Suppose AD increases and real GDP rises above $Y_f$. Jobs are plentiful, so workers bargain for higher nominal wages and input prices rise. Costs rise, SRAS shifts left, and the economy moves up along the new AD curve until real GDP returns to $Y_f$ at a higher price level. You will study this self-adjustment in the AD–AS equilibrium page.

Summary