Lesson preview · Aggregate Supply
Aggregate Supply
~14 min · Free to read
In 1973, oil-producing nations cut their exports and the price of crude oil quadrupled in months. The same thing happened again in 2022 after Russia invaded Ukraine. Every firm that burns fuel, ships goods, or runs machines saw its costs jump overnight. Petrol queues formed, factories slowed, and prices in the shops climbed even as output fell.
Aggregate demand cannot explain that. Demand falling should pull prices down, not up. To see why prices and output can move in opposite directions, we need the other half of the model: the supply side.
Key Term
Aggregate supply — what firms are willing to produce
Aggregate supply (AS) is the total quantity of output that a country’s firms are willing to produce at each price level. The price level is the overall cost of everything, measured by a price index like the CPI.
There are two versions, and the whole lesson turns on the difference between them: a short-run curve and a long-run curve. They behave in opposite ways, and confusing them is the most common mistake students make here.
Key Term
Short-run aggregate supply (SRAS) slopes up
Short-run aggregate supply (SRAS) is what firms produce when their costs have not yet caught up with prices. It slopes upward: a higher price level means more output.
The reason is sticky wages — wages and many input prices are locked in for a while, set by contracts that are slow to renegotiate. Picture a factory paying workers a fixed hourly wage agreed last year. When the overall price level rises, the firm sells its output for more, but it still pays the same old wage. Its profit on each unit widens. So it hires extra shifts and produces more.
A higher price level → wider profit margins (because wages lag) → more output. That is why SRAS slopes up.
Key Term
Long-run aggregate supply (LRAS) is vertical
Give it enough time and the trick stops working. Workers see that everything costs more, contracts expire, and wages get renegotiated upward to match the higher price level. Input prices catch up too.
Once wages have fully adjusted, the extra profit margin disappears. Firms no longer have any reason to produce above their normal level. Output settles back at potential output (Yp) — the amount the economy produces when all its resources are used normally, at full employment.
So long-run aggregate supply (LRAS) is a vertical line at Yp. In the long run, the price level can be anything; output is still pinned to potential. Doubling all prices and all wages together changes nothing real.
That is the heart of it. In the short run, sticky wages let a higher price level pull more output out of firms, so SRAS slopes up. In the long run, wages catch up, the extra margin vanishes, and output returns to potential whatever the price level — so LRAS stands straight up.
Trap · Common Misconception
"LRAS slopes up like SRAS, just steeper"
It is tempting to draw long-run aggregate supply as a steep upward line. It is not steep — it is vertical. The logic is different in kind, not in degree. In the long run, wages and input prices have fully adjusted to the price level, so there is no leftover profit margin to coax out extra production. Output is fixed at potential, and only the price level is free to move. A vertical line is the only shape that says “output is the same at every price level.” A steep-but-sloped line would still claim that higher prices buy more output forever, which is exactly the short-run story that the long run undoes.
Key Term
Movement along vs a shift
Keep three different moves apart:
- A change in the price level moves you along SRAS (the dot slides up or down the orange line). This is what the widget shows.
- A change in input costs — wages, oil, raw materials — shifts SRAS left or right at every price level. Cheaper inputs shift it right (firms produce more at any price); a cost shock shifts it left.
- A change in potential output itself — more or better workers, capital, technology, or institutions — shifts LRAS. Only things that change what the economy can produce at full employment move the vertical line.
A supply shock is a sudden jump in input costs, like the oil price quadrupling. It shifts SRAS left: less output at every price level, and a higher price level to boot.
Check yourself · no marks
A new oil discovery permanently lowers energy costs across the whole economy. Does this shift SRAS, LRAS, or both — and which way?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Worked Example
An economy is sitting at potential output, which we set to 100. An oil-producing region then cuts exports and crude oil prices spike, raising input costs across every industry. In the short run, output falls to 94 while the price level rises. Walk through what happens to the curves, and explain where output ends up once the long run arrives.
Practice · 1 / 4
Why does the short-run aggregate supply (SRAS) curve slope upward?
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