Aggregate supply is the total amount of goods and services all the economy’s producers are willing and able to offer at any given price level. The aggregate supply curve shows the relationship between the price level and the total amount of goods and services supplied in an economy.
Short-run aggregate supply curve (SRAS)
In the short run, the prices of inputs and technology are unchanged. It takes time before wages or prices of other inputs are changed by the suppliers even though demand changes. For instance, it takes time before wages are renegotiated between employers and workers’ unions. They are kept constant when drawing the SRAS curve.
The SRAS curve slopes upward indicating that as the price level increases, output supplied in the economy will also increase. This is because producers will have to raise prices to cover the cost of increasing output. For example, the wage rate may remain the same but the workers have to be paid overtime for them to work longer than the normal working hours per week to produce more output.
Figure 1: Decrease in short-run aggregate supply
The SRAS curve can shift because of changes in costs. If the factors that are kept constant in the short-run change, the aggregate supply curve will shift, e.g. wage rate, raw material costs, taxation, etc. If raw materials cost increases, the SRAS will decrease and the SRAS curve will shift to the left (Figure 1 above). A fall in the corporate tax rate will increase SRAS and shift the SRAS curve to the right (Figure 2 below).
Figure 2: Increase in short-run aggregate supply
There can also be a movement along the aggregate supply curve caused by a change in the price level. An increase in the price level will lead to an extension of the aggregate supply or increase in aggregate supply quantity (Figure 3 below) while a decrease in the price level will lead to a contraction of aggregate supply or decrease in aggregate supply quantity (Figure 4 below).
Figure 3: Extension of short-run aggregate supply
Figure 4: Contraction of short-run aggregate supply
Long-run aggregate supply curve(LRAS)
LRAS is the total supply in an economy when prices of inputs are not constant. Changes in the prices of factors of production have been adjusted to in the long run. There are two types of LRAS curves, namely Classical LRAS and Keynesian LRAS. The Classical LRAS curve is a vertical line because the classical economists are of the belief that in the long run all resources are fully used and the output is maximised (Figure 5 below).
Figure 5: Classical long-run aggregate supply curve
The Keynesian LRAS curve has three parts (Figure 6 below). It is perfectly elastic first (line A), that is horizontal; then it slopes upward (line B), and finally, it becomes a vertical line (line C). Initially, not all resources are used; their prices do not increase so the price level remains unchanged (line A). As output increases, more resources are needed; the increased demand for resources pushes their prices up, thereby leading to a rise in the price level (line B); the final stage is when all resources are fully employed and total output is fixed (line C).
Figure 6: Keynesian long-run aggregate supply curve
The LRAS curve shows what the economy can produce if all resources are fully used. So, a shift in the LRAS curve occurs when the quantity and quality of factors of production change. An increase in the labour force as a result of net immigration or an increase in retirement age will increase the amount of resource (labour) available and shift the LRAS curve to the right (Figures 7 and 8 below). Technological advancement can increase the quality of machines by making them more productive/efficient, thereby causing a rightward shift in the LRAS curve. Note that these two factors (quantity and quality of resources) also have the capacity to shift the aggregate supply curve in the short run.
Figure 7: Shift in the Classical LRAS Curve
Figure 8: Shift in the Keynesian LRAS Curve