Aggregate Supply: Short Run and Long Run

Aggregate Supply (AS) represents the total quantity of goods and services that producers in an economy are willing and able to supply at each given price level. While Aggregate Demand shows the spending side of the economy, Aggregate Supply captures the production side. The distinction between Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS) is one of the most important analytical frameworks in A-Level economics — and one of the most contested.

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Defining Aggregate Supply

Concept	Definition
Aggregate Supply (AS)	The total output of goods and services that all producers in an economy are willing and able to supply at each price level in a given time period
Short-Run Aggregate Supply (SRAS)	AS when at least some factor prices (especially wages) are fixed or sticky — typically assumed to be a period of up to two years
Long-Run Aggregate Supply (LRAS)	AS when all factor prices have fully adjusted to changes in the price level — representing the economy's full productive capacity

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Short-Run Aggregate Supply (SRAS)

The SRAS curve slopes upward from left to right: as the price level rises, firms are willing to supply more output.

Why Does SRAS Slope Upward?

Reason	Explanation
Sticky wages	In the short run, nominal wages are fixed by contracts. When the price level rises, the real cost of labour falls (workers are effectively cheaper), so firms hire more workers and produce more output. This "money illusion" was emphasised by Keynes (1936).
Menu costs	Some firms are slow to adjust their prices (costs of changing price lists, catalogues, etc.), so when the general price level rises, these firms find their relative prices lower and sell more.
Imperfect information	Firms may initially interpret a general rise in the price level as an increase in demand for their specific product, leading them to increase output. Robert Lucas (1972) formalised this idea.
Fixed input prices	Raw material contracts, energy prices, and rent may be fixed in the short run. When output prices rise but input costs stay fixed, profit margins increase, incentivising greater production.

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Shifts of the SRAS Curve

The SRAS curve shifts when costs of production change (at any given price level):

Factor	Direction of Shift	Explanation
Rise in raw material costs	SRAS shifts left	Higher costs reduce the amount firms are willing to supply at each price level — e.g., oil price rises in 1973, 2022
Fall in raw material costs	SRAS shifts right	Lower costs increase profitability and output — e.g., falling oil prices in 2014–15
Wage increases	SRAS shifts left	Higher wages increase unit labour costs — especially if wages rise faster than productivity
Exchange rate depreciation	SRAS shifts left	Imported raw materials and components become more expensive, raising production costs
Exchange rate appreciation	SRAS shifts right	Imported inputs become cheaper
Changes in indirect taxes	Either direction	A rise in VAT shifts SRAS left (higher costs); a cut shifts SRAS right
Supply-side shocks	Either direction	Natural disasters, pandemics (COVID-19), wars (Russia-Ukraine conflict 2022) shift SRAS left; technological breakthroughs shift it right
Productivity changes	SRAS shifts right if productivity rises	Higher output per worker reduces unit costs

Exam Tip: When analysing a shift in SRAS, always identify the specific cost change that causes the shift. "SRAS shifts left because costs rise" is too vague — specify whether it is wages, energy costs, raw materials, exchange rates, or taxes.

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Long-Run Aggregate Supply (LRAS)

In the long run, all factor prices (including wages) adjust fully to changes in the price level. The position and shape of the LRAS curve depend on which school of economic thought you follow.

The Classical/New Classical LRAS

Classical and monetarist economists argue that the LRAS curve is vertical at the full employment level of output (Yn or Yfe).

Key Feature	Explanation
Vertical at Yn	In the long run, the economy produces at its full capacity regardless of the price level. Output is determined by the quantity and quality of factors of production, not by the price level.
Based on Say's Law	Jean-Baptiste Say (1803) argued that supply creates its own demand — in the long run, the economy tends towards full employment
Self-correcting mechanism	If AD falls, the price level and wages eventually adjust downwards, restoring full employment output. No need for government intervention.
Natural rate of unemployment	Milton Friedman (1968) and Edmund Phelps (1968) independently argued that there is a natural rate of unemployment consistent with stable inflation — the LRAS represents output at this natural rate

Shifts of the Classical LRAS

The LRAS shifts when the economy's productive capacity changes: