Supply shocks change firms’ costs and productive conditions, altering inflation at any given unemployment rate. Understanding how these shocks shift the short-run Phillips curve is essential for diagnosing stagflation and policy trade-offs.

Core idea: shifts vs. movements on the SRPC

The short-run Phillips curve (SRPC) shows the short-run relationship between inflation and unemployment. A change in aggregate demand typically moves the economy along a given SRPC, while a supply shock shifts the entire SRPC.

Supply shocks matter because they change inflation even if unemployment does not change, which is exactly what a shift of the SRPC represents.

What it means for the SRPC to shift

Interpreting a shift

A shift of the SRPC means: at every unemployment rate, inflation is different than before.

• SRPC shifts right (up): higher inflation at each unemployment rate (worse inflation–unemployment menu).

• SRPC shifts left (down): lower inflation at each unemployment rate (better inflation–unemployment menu).

A compact way to model the idea (optional but useful)

A common expectations-augmented form captures how supply shocks enter inflation.

In this setup, changes in $v$ shift the SRPC because they change inflation holding unemployment fixed.

Adverse supply shocks (SRPC shifts right/up)

An adverse supply shock raises unit production costs or reduces effective supply conditions. Typical channels include:

• Commodity price spikes (especially energy): higher transportation, heating, and input costs.

• Negative productivity shocks: output per worker falls, raising per-unit costs.

• Supply chain disruptions or natural disasters: shortages raise input prices and slow production.

• Sudden increases in wages not matched by productivity (e.g., from bargaining power shifts): higher labour costs per unit.

Macroeconomic implications (what you should be able to state clearly):

• Inflation rises (cost-push inflation).

• Real output tends to fall, so unemployment rises.

• The economy can experience stagflation: higher inflation with higher unemployment.

Graphically (described): the economy may move to a point with higher inflation and higher unemployment because the SRPC itself shifts right/up.

This AD–AS diagram illustrates cost-push inflation from an adverse supply shock: short-run aggregate supply shifts left (AS to AS′), raising the price level while reducing real output. That combination corresponds to rising inflation and rising unemployment—exactly the stagflation pattern that accompanies an outward (up/right) shift of the SRPC. Source

Favourable supply shocks (SRPC shifts left/down)

A favourable supply shock lowers production costs or improves productive conditions, such as:

• Falling energy/input prices

• Productivity improvements (better technology or processes)

• Resolution of bottlenecks (shipping/logistics normalise)

• Cost-reducing innovations that spread across firms

Macroeconomic implications:

• Inflation falls at a given unemployment rate.

• Real output rises, so unemployment falls.

• The economy can achieve lower inflation and lower unemployment in the short run, reflecting a left/down shift of the SRPC.

How to distinguish supply-shock inflation from demand-driven inflation

When diagnosing the source of inflation, focus on the unemployment direction:

• Demand-driven inflation: inflation rises while unemployment tends to fall (movement along SRPC).

• Supply-shock inflation: inflation rises while unemployment tends to rise (SRPC shifts right/up).

In words, supply shocks worsen the trade-off, while demand changes usually pick a different point on the same trade-off.

Policy significance (within this subtopic)

Supply shocks create a difficult short-run menu:

• Stabilising inflation after an adverse shock often risks higher unemployment.

• Stabilising unemployment/output often risks higher inflation. This dilemma is a direct consequence of the SRPC shifting, not merely moving along it.