Aggregate Supply (AS) refers to the total output of goods and services that firms in an economy are willing to produce and sell at various price levels over a given time period.
Definition of aggregate supply
Aggregate Supply (AS) is defined as the total quantity of goods and services that producers in an economy are willing and able to supply at a given overall price level in a specified time period.
This concept is fundamental to macroeconomic analysis, as it reflects the productive capacity of an economy and helps determine national output alongside Aggregate Demand (AD). AS represents the economy's supply-side activity, taking into account how willing and capable firms are to respond to different price levels by adjusting their output.
AS considers all sectors of the economy and aggregates their output intentions.
It focuses on real output (real GDP) rather than nominal values.
The AS curve is not fixed—it can change over time depending on changes in costs, resources, technology, and other structural factors.
Aggregate Supply must be distinguished from microeconomic supply:
In microeconomics, supply refers to the quantity of a particular good that a firm is willing to produce.
In macroeconomics, AS deals with total output across the whole economy.
The aggregate supply curve
General representation of the AS curve
The Aggregate Supply Curve illustrates the relationship between the general price level (measured by a price index such as the GDP deflator) and the real national output that firms in the economy are willing to supply.
There are two key types of aggregate supply curves, corresponding to the short run and long run:
Short-run aggregate supply (SRAS): shows how output responds to price changes when factor costs (especially wages) are fixed.
Long-run aggregate supply (LRAS): shows the potential output of the economy when all resources are fully employed.
Each curve reflects different assumptions about the flexibility of prices, wages, and other costs.
Short-run aggregate supply (SRAS) curve
The short-run aggregate supply curve is upward sloping, indicating that as the price level rises, firms are encouraged to increase output. This is due to the perception of higher profitability when output prices rise faster than input costs, which are sticky or fixed in the short term.
Key assumptions of SRAS:
Nominal wages and input costs are fixed in the short term.
Firms face increasing marginal costs as output rises due to diminishing returns and capacity constraints.
Firms are willing to increase production when selling prices increase, even if costs remain constant temporarily.
Why is the SRAS curve upward-sloping?
If the general price level increases, firms receive higher revenue per unit of output.
With fixed input costs, higher prices mean increased profits, encouraging firms to produce more.
As output expands, some firms may experience increased costs due to overtime, bottlenecks, and capacity pressures, contributing to the slope.
In graphical terms, the SRAS curve starts at the origin and slopes gently upwards. At lower levels of output, spare capacity allows for output increases without major cost rises. At higher levels, the curve becomes steeper as resources become more scarce.
Long-run aggregate supply (LRAS) curve
The long-run aggregate supply curve shows the relationship between the price level and output when all input prices (including wages) are fully flexible and the economy is operating at full productive capacity.
LRAS reflects the economy's maximum sustainable output level when resources are used efficiently. Unlike SRAS, LRAS is not influenced by changes in the price level.
Classical (vertical) LRAS curve
The classical or monetarist view holds that the LRAS curve is perfectly vertical.
This implies that in the long run, the economy always returns to full employment regardless of short-term fluctuations.
The vertical LRAS curve reflects a fixed level of potential output, determined by the economy’s supply-side factors such as:
Labour force size
Capital stock
Technological progress
Productivity levels
Institutional efficiency
Changes in the price level do not affect the long-run level of output, as any increase in nominal variables is offset by corresponding changes in wages and costs.
This approach supports the idea that demand-side policies are ineffective in the long run and that economic growth depends on supply-side reforms.
Keynesian (curve-shaped) LRAS curve
The Keynesian view presents a more nuanced shape for the LRAS curve, acknowledging that market imperfections and rigidities can prevent full employment.
The Keynesian LRAS curve has three distinct segments:
Horizontal (perfectly elastic) section:
Represents an economy with substantial spare capacity.
Firms can increase output without raising prices due to unemployed resources.
Reflects recession or depression conditions.
Upward-sloping section:
As spare capacity diminishes, firms must bid for scarce resources.
Prices and wages begin to rise.
Output can still increase, but with inflationary pressure.
Vertical section:
Indicates the economy has reached full capacity.
Any further increase in demand will result only in higher prices, not higher output.
Represents inflationary overheating.
The Keynesian model implies that government intervention may be necessary to close output gaps and boost employment when the economy is operating below capacity.
Movements along the AS curve
A movement along the aggregate supply curve occurs when the price level changes, with all other factors held constant.
This movement is a response to changes in aggregate demand, and not a change in underlying supply conditions.
Upward movement (expansion)
Occurs when the price level rises.
Firms increase output to take advantage of higher prices and improve profitability.
In SRAS, input costs remain fixed, so firms can enjoy short-term profit gains.
Downward movement (contraction)
Triggered by a fall in the price level.
Firms respond by cutting output, as lower prices reduce revenue per unit and compress profit margins.
With costs unchanged, producing the same output becomes less attractive.
Important note
Movements along the curve are due to price level changes only.
They do not reflect any change in underlying supply capacity.
The economy moves along the existing AS curve without changing its position.
Shifts of the AS curve
A shift of the AS curve occurs when non-price factors change, affecting firms’ ability or willingness to supply goods and services at all price levels.
In other words, at every price level, the quantity supplied has increased or decreased.
Causes of shifts in SRAS
These shifts typically occur due to changes in cost conditions or short-term supply-side shocks.
Key factors:
Changes in input prices:
Increases in the cost of raw materials or energy (e.g. oil prices) lead to higher production costs.
This causes the SRAS curve to shift left, indicating reduced supply.
Falling input prices cause a rightward shift, increasing supply.
Exchange rate movements:
A stronger currency reduces the cost of imported raw materials.
This lowers input costs and shifts SRAS right.
A weaker currency makes imports more expensive, reducing SRAS.
Taxation changes:
Higher taxes on firms (corporation tax, VAT) increase costs and reduce SRAS.
Lower taxes boost incentives and reduce costs, increasing SRAS.
Supply-side shocks:
Natural disasters, global supply disruptions, or pandemics can affect production capability, causing leftward shifts in SRAS.
Wage changes:
If wages rise faster than productivity, unit labour costs increase, reducing SRAS.
The magnitude of the shift depends on how significantly these factors affect average costs and profitability.
Causes of shifts in LRAS
Though this is explored in more detail in section 2.3.3, it’s important to understand the distinct nature of LRAS shifts.
LRAS shifts reflect changes in the economy’s productive capacity.
Influenced by long-term structural factors, including:
Technological innovation
Capital investment
Education and training
Labour market flexibility
Regulatory environment
Unlike SRAS, these shifts take years to manifest and reflect a sustained increase or decrease in potential output.
Difference between movement and shift
It is crucial to distinguish between a movement along an AS curve and a shift of the AS curve:
A movement is caused only by a change in the price level, with all other factors constant. It does not involve any change in the underlying ability to produce.
A shift happens when non-price factors change (such as costs or capacity), meaning the economy now supplies more or less at every price level.
Students often confuse the two:
If AD increases, causing higher prices and more output: this is a movement along SRAS.
If wage costs rise, reducing firms’ willingness to produce at all price levels: this is a leftward shift of SRAS.
Distinguishing between short-run and long-run aggregate supply
Short-run aggregate supply (SRAS)
SRAS represents output decisions under the assumption that some input costs are fixed, particularly nominal wages.
Key characteristics:
Prices of goods and services can change, but costs (especially wages) are slow to adjust.
Firms make decisions based on expected profitability, not on long-run efficiency.
Temporary fluctuations in output and employment are possible.
SRAS is highly relevant for analysing:
The effect of fiscal and monetary policy in the short term.
Inflationary or deflationary gaps.
Business cycle fluctuations.
Long-run aggregate supply (LRAS)
LRAS assumes that all factor markets adjust, and that wages and prices are flexible in the long term.
Key characteristics:
The economy reaches its full productive potential.
Output is determined by real factors, such as technology and productivity, not by prices.
There is no trade-off between inflation and unemployment in the long run (classical view).
LRAS is the benchmark for:
Long-term economic growth strategies.
Supply-side policies.
Analysis of productivity trends and capacity expansion.
FAQ
The short-run aggregate supply (SRAS) curve assumes fixed input prices because, in the short term, many production costs such as wages, rent, and some raw materials do not adjust immediately to changes in market conditions. This “sticky” behaviour occurs due to contracts, menu costs, and the time needed to renegotiate wages or source alternative suppliers. Firms base short-term decisions on expected rather than actual input cost changes, leading to a profit motive when output prices rise. In modern economies, while some prices are more flexible than in the past due to technological advances and dynamic supply chains, many key inputs like labour costs still adjust slowly, especially in industries with unionised labour or fixed-term contracts. Therefore, although the assumption of fixed input prices may oversimplify some sectors, it remains broadly realistic for capturing the behaviour of most firms over a period of a few months to a year, justifying the use of SRAS in short-run macroeconomic modelling.
Yes, behavioural and psychological factors can influence aggregate supply, particularly in the short run. While traditional models assume rational decision-making based on prices and costs, firms and workers are also influenced by expectations, confidence, and perceptions of risk. For example, if firms anticipate an economic downturn or political instability, they may reduce output or delay investment, shifting SRAS leftward even if input prices remain constant. Similarly, workers may resist nominal wage cuts during recessions due to “money illusion” or concerns about fairness, leading to wage rigidity and reduced supply flexibility. Fear of inflation or deflation can also impact production decisions. In addition, sentiment-driven shifts in consumer demand may affect supply decisions, as firms pre-emptively adjust production in response to perceived market trends. Behavioural economics adds nuance to aggregate supply analysis by highlighting that expectations, norms, and heuristics can cause deviations from purely cost-based responses in both the short and long run.
Inflation expectations significantly affect the short-run aggregate supply (SRAS) curve. When firms and workers expect higher future inflation, they may adjust prices and wages in advance. For example, if firms expect costs to rise due to inflation, they are likely to increase their own prices earlier, reducing supply at current price levels. This behaviour causes the SRAS curve to shift leftwards, as the economy supplies less output at each given price level. Likewise, if workers expect future inflation, they may demand higher wages to protect real incomes, increasing firms’ labour costs and reducing profitability. Over time, these adjustments can also steepen the SRAS curve, making output more sensitive to price changes. In economies with stable and low inflation expectations, the SRAS curve is likely to be flatter and more stable. However, if expectations become unanchored, perhaps due to poor monetary policy credibility, the curve may become more volatile and prone to shifting unpredictably.
Productivity improvements can affect not just the position but also the slope or elasticity of the short-run aggregate supply (SRAS) curve. If firms become more productive—producing more output with the same inputs—they can supply additional goods and services at lower or unchanged costs. This increased efficiency reduces pressure on prices when output rises, making the SRAS curve flatter (more elastic). A flatter SRAS implies that increases in aggregate demand will lead to larger changes in output and smaller increases in the price level. On the other hand, in sectors with low productivity growth or capacity constraints, the SRAS curve is steeper because any attempt to increase output leads quickly to higher costs and inflation. In the short run, widespread productivity improvements (e.g. through automation or better management practices) allow firms to respond to higher demand with higher output rather than higher prices, helping to reduce inflationary pressure and enhancing macroeconomic stability.
Different sectors of the economy contribute to the shape and responsiveness of the aggregate supply (AS) curve in varied ways due to differences in cost structures, flexibility, and capacity constraints. For instance, the services sector often has more labour-intensive operations and may experience more sticky wages, making its SRAS relatively less elastic. On the other hand, the manufacturing sector, especially with modern supply chains and technological integration, can adjust output more quickly to price changes, contributing to a more elastic portion of the curve. Primary industries like agriculture are heavily affected by seasonal factors and natural conditions, leading to abrupt and sometimes volatile supply changes that can steepen the SRAS. Moreover, some sectors such as energy or transport infrastructure have high fixed costs and capacity limitations, making them slower to adjust in the short run. Thus, the aggregate supply curve reflects a blended response from all sectors, with more flexible and responsive industries flattening the SRAS and rigid, capacity-constrained sectors steepening it.
Practice Questions
Explain the difference between a movement along the aggregate supply curve and a shift of the aggregate supply curve.
A movement along the aggregate supply (AS) curve occurs when the price level changes, causing a change in the quantity of output supplied, with all other factors held constant. For example, a rise in the general price level leads to an expansion along the short-run AS curve. In contrast, a shift of the AS curve happens when non-price factors, such as changes in wage rates, input costs, or exchange rates, alter firms’ production capacity at all price levels. A leftward shift indicates reduced supply due to higher costs, while a rightward shift reflects improved supply conditions.
With reference to a diagram, explain the difference between the classical and Keynesian views of the long-run aggregate supply curve.
The classical long-run aggregate supply (LRAS) curve is vertical, showing that in the long run, output is fixed at full employment and is unaffected by changes in the price level. This reflects the belief that the economy self-corrects through flexible wages and prices. In contrast, the Keynesian LRAS curve is curve-shaped, consisting of horizontal, upward-sloping, and vertical segments. It shows that when spare capacity exists, output can rise without price increases. Only when full capacity is reached does the curve become vertical. This view allows for persistent unemployment and justifies government intervention during downturns.
