# Aggregate Supply

> IB Economics SL · IB Economics SL
> Source: https://www.owlsprep.com/study/ib-economics-sl-u3-aggregate-supply/

Aggregate supply (AS) measures the total quantity of goods and services an economy produces at different price levels, and forms the core of the AD-AS macro model. This module covers SRAS/LRAS differences, shift factors, and exam applications.

**Prerequisites:** [Aggregate demand](https://www.owlsprep.com/study/ib-economics-sl-u3-aggregate-demand/); [AD-AS model basics](https://www.owlsprep.com/study/ib-economics-sl-u3-intro-to-ad-as/)

## Learning objectives

- Distinguish between short-run and long-run aggregate supply curves
- Identify and explain factors that shift SRAS and LRAS
- Analyze the impact of supply shocks and policy on aggregate supply
- Correctly draw and interpret aggregate supply diagrams for exam questions

## Core Definitions: SRAS vs LRAS

**Short-Run Aggregate Supply (SRAS)** — In the short run, nominal wages and other input prices are 'sticky' (they do not adjust immediately to changes in output prices). As output prices rise and input prices stay constant, firm profitability increases, so firms increase production. This gives SRAS an upward slope.

*Example:* A 10% rise in output prices with unchanged input wages leads firms to hire more workers and increase output.

**Long-Run Aggregate Supply (LRAS)** — In the long run, all prices and wages are fully flexible. The level of output depends only on the quantity and productivity of factors of production (labour, capital, technology), so LRAS is vertical at the economy's potential (full employment) output, regardless of the price level.

*Example:* A 10% rise in all prices (output and inputs) leaves profitability unchanged, so output stays at potential output.

**Worked example:** Draw and label SRAS and LRAS for an economy with potential output of \text{\textasciitilde}500 billion, and explain why their slopes differ.

1. Draw axes with price level on the y-axis and real GDP on the x-axis. Mark Yp = \text{\textasciitilde}500 billion on the x-axis.
2. Draw an upward-sloping line labelled SRAS. Draw a vertical line labelled LRAS that intersects the x-axis at Yp = \text{\textasciitilde}500 billion.
3. Explain SRAS slope: Sticky input prices mean higher output prices increase profitability, so firms increase output, leading to an upward slope.
4. Explain LRAS slope: Full price and wage flexibility means changes in the price level do not change profitability or long-run potential output, hence the vertical slope.

> **Exam tip:** Always label your curves clearly (SRAS not just AS) to avoid losing marks in diagram questions.

## Shift Factors for SRAS and LRAS

Only changes in the price level cause a *movement along* an existing AS curve. Any change to a non-price determinant of output causes a *shift* of the entire curve. Different factors shift SRAS and LRAS.

- SRAS shifts in response to changes in nominal wages, raw material prices (e.g. oil), business taxes, subsidies, and temporary supply shocks.
- LRAS shifts only when the economy's potential output changes, i.e. from changes to the quantity or quality of factors of production.

**Supply Shock** — An unexpected event that changes production costs and shifts the SRAS curve. Negative shocks shift SRAS left; positive shocks shift SRAS right.

*Example:* A global pandemic that disrupts supply chains is a negative supply shock.

**Worked example:** For each event, state which curve shifts and the direction: (a) A permanent improvement in production technology, (b) A temporary spike in global oil prices, (c) A permanent increase in the nominal minimum wage.

1. (a) Permanent technology improvement increases potential output, so it shifts LRAS right. It also permanently lowers production costs, so SRAS shifts right too.
2. (b) Temporary oil price spike raises short-run production costs but does not change long-run potential output, so only SRAS shifts left, with no change to LRAS.
3. (c) A permanent increase in the minimum wage raises long-run production costs and increases natural unemployment, so it shifts both SRAS and LRAS left.

**Check your understanding**

Test your understanding:

1. A natural disaster permanently destroys 20% of a country's capital stock. What is the impact on LRAS?

   - LRAS shifts left
   - LRAS shifts right
   - No change, only SRAS shifts left

   *Why:* A permanent reduction in capital stock reduces the economy's potential output, so both LRAS and SRAS shift left.

## Aggregate Supply for Policy Analysis

Aggregate supply analysis is the foundation for evaluating macroeconomic shocks and government policy, and is a common topic for both paper 1 and paper 2 exam questions.

**Exam command terms**

- **Analyze the impact of a negative supply shock** — You must draw the shift of SRAS, explain the impact on real GDP and price level, and discuss short-run policy trade-offs. *(You will typically be expected to explain the resulting stagflation (low growth + high inflation).)*

- **Evaluate supply-side policies to increase AS** — You need to explain how policies shift LRAS right, then discuss advantages (higher growth, lower inflation) and disadvantages (inequality, public debt).

**Worked example:** Using an AD-AS diagram, analyze the short-run impact of a negative supply shock on an economy initially at full employment.

1. Start with an initial equilibrium where AD intersects SRAS on the vertical LRAS curve at full employment output Yp and price level P1.
2. The negative supply shock (e.g. an oil price rise) shifts SRAS left to a new position SRAS₂.
3. The new short-run equilibrium is at the intersection of AD and SRAS₂, with lower real GDP Y₂ (Y₂ < Yp) and higher price level P₂ (P₂ > P1). This outcome is called stagflation.
4. Without government intervention, high unemployment eventually pushes nominal wages down, shifting SRAS back to its original position, returning the economy to full employment in the long run.

## Common pitfalls

- **Wrong:** Confusing a movement along SRAS with a shift of SRAS.
  - Why it fails: Only changes in the overall price level cause a movement along the curve. All other changes to output determinants shift the entire curve.
  - Correct: Always ask: is the change to the price level (movement) or another factor (shift) before drawing your diagram.
- **Wrong:** Claiming any shift of SRAS must also shift LRAS.
  - Why it fails: Temporary changes to production costs only shift SRAS and do not alter the economy's long-run potential output.
  - Correct: Only changes to the quantity or quality of factors of production shift LRAS.
- **Wrong:** Drawing LRAS as upward-sloping for classical analysis.
  - Why it fails: The classical model assumes full price/wage flexibility in the long run, so LRAS must be vertical at potential output.
  - Correct: Only draw an upward-sloping or horizontal LRAS if the question specifically asks for the Keynesian LRAS model.
- **Wrong:** Treating potential output as a permanently fixed value.
  - Why it fails: Potential output grows over time from population growth, capital accumulation, and technological progress, so LRAS shifts right over time.
  - Correct: Always note that LRAS can shift when potential output changes, even in the long run.

## Cheatsheet

| Change | SRAS shift | LRAS shift |
| --- | --- | --- |
| Temporary oil price spike | Left | None |
| Permanent technology improvement | Right | Right |
| Permanent minimum wage rise | Left | Left |
| Increase in size of labour force | Right | Right |
| Temporary natural disaster supply disruption | Left | None |
| Improved access to higher education | Right | Right |

## What's next

Understanding aggregate supply completes the core AD-AS model, which you will use to analyze all major macroeconomic topics from shocks to government policy to long-run growth. This topic is foundational for evaluating the impact of fiscal, monetary, and supply-side policies, and understanding the key debate between Keynesian and classical macroeconomic perspectives, which appears frequently in both paper 1 and paper 2 IB exams. Mastery of AS shift factors and the difference between short-run and long-run output is critical for earning full marks on diagram-based and essay questions.

- [Macroeconomic Equilibrium](https://www.owlsprep.com/study/ib-economics-sl-u3-macroeconomic-equilibrium/)
- [Long-Run Economic Growth](https://www.owlsprep.com/study/ib-economics-sl-u3-economic-growth/)
- [Unemployment and inflation](https://www.owlsprep.com/study/ib-economics-sl-u3-unemployment-and-inflation/)

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