Aggregate Supply

Specification Coverage: Edexcel unit 2.3.1 - Aggregate Supply. Students should be able to understand and explain short-run aggregate supply and long-run aggregate supply, why the SRAS curve slopes upward, the difference between movements along and shifts of SRAS, the main determinants of SRAS, and how LRAS represents productive potential and long-run economic growth. These notes also cover the Keynesian and Classical models of the aggregate supply curve.

Short-Run Aggregate Supply (SRAS)

Definition: Short-run aggregate supply is the total planned output of goods and services in an economy at a given price level in a period where at least one factor of production is fixed, such as the capital stock or technology.

The SRAS Curve

Short-run aggregate supply sloping upward, as a higher price level draws out more output while costs are fixed
Figure 1: The aggregate supply curve, showing the positive relationship between the average price level and the quantity of real GDP supplied.

Why the SRAS Curve Slopes Upward

In the short run, as output increases, firms face rising unit costs, such as paying overtime wages or using less efficient machinery.

To maintain profitability, firms need to charge higher prices for this extra output.

Movements vs. Shifts of the SRAS Curve

A Movement Along the SRAS Curve

  • Cause: A change in the average price level, holding other things constant.
  • This shows firms changing their level of output in response to a change in price level.

A Shift of the Entire SRAS Curve

  • Cause: A change in any condition of SRAS, meaning a change in production costs for firms across the economy.
  • This changes the level of output firms are willing to supply at every given price level.
  • These conditions are covered in 2.3.2 Short-Run Aggregate Supply.
Short-run aggregate supply shifting right as production costs fall, raising real output and lowering the price level
Figure 2: A shift of the SRAS curve to the right (SRAS1 to SRAS2) due to a decrease in production costs.

Long-Run Aggregate Supply (LRAS)

Definition: Long-run aggregate supply is the total potential output of an economy when all factors of production are fully and efficiently employed.

It represents the economy's productive capacity.

Key Idea: The LRAS curve is independent of the price level. It depends on the quantity and quality of the factors of production, such as labour, capital, resources, technology, and entrepreneurship.

Classical long-run aggregate supply drawn vertical at full employment, so demand changes affect only the price level
Figure 3: The long-run aggregate supply curve is vertical, indicating that the economy's potential output is not affected by changes in the price level.

The Relationship Between SRAS and LRAS

  • SRAS shows what firms will produce at different price levels in the short run.
  • LRAS shows what the economy can produce at maximum potential.
  • Long-run economic growth is shown by an outward shift of the LRAS curve, meaning an increase in productive capacity.
  • In the long run, the economy tends towards the LRAS level of output, while SRAS shocks are temporary adjustments around that trend.

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Seven original multiple-choice questions on short-run and long-run aggregate supply, the slope of SRAS, and what productive capacity means.

Practice Questions: 2.3.1 Aggregate Supply