📊 Short-Run Aggregate Supply (SRAS)
Definition: SRAS. It slopes upward: higher prices → higher profits → firms produce more.
Factors that shift SRAS
- Input prices — wages, raw materials, energy costs. Higher costs → SRAS shifts left.
- Indirect taxes and subsidies — taxes raise costs (SRAS left), subsidies lower them (SRAS right).
- Supply shocks — a natural disaster or pandemic disrupts production (SRAS left); a bumper harvest or tech breakthrough reduces costs (SRAS right).
- Exchange rate — depreciation raises import costs → SRAS left.
Think of SRAS shifts as changes in costs of production at the macro level. Anything that raises costs shifts SRAS left; anything that lowers costs shifts it right.
📊 Long-Run Aggregate Supply (LRAS)
Definition: LRAS.
Two models of LRAS
- New classical (monetarist) model — LRAS is a vertical line at full-employment output (Yf). In the long run, output is determined by supply-side factors, not the price level.
- Keynesian model — LRAS is horizontal when there is spare capacity (firms can increase output without raising prices), then curves upward as the economy approaches capacity, and eventually becomes vertical at full employment.
The IB expects you to know both models. Use the new classical model as your default for most macro analysis, but mention the Keynesian perspective when discussing recession and spare capacity.
Shifting LRAS
- LRAS shifts right when the economy's productive capacity increases: more/better resources, improved technology, better education, institutional reforms.
- LRAS shifts left (rare): destruction of capital (war, disaster), loss of workforce (emigration), resource depletion.
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⚖️ SRAS vs LRAS — Quick Comparison
- SRAS = upward-sloping, shifts with costs (wages, materials, energy).
- LRAS = vertical (new classical) or shaped (Keynesian), shifts with capacity (technology, labour force, capital).
- Short-run: wages and some costs are sticky → firms respond to price changes by adjusting output.
- Long-run: all prices and wages adjust → output returns to potential GDP regardless of price level.
The key insight: In the short run, both demand and supply shocks affect output and prices. In the long run, only supply-side improvements can increase the economy's maximum output. This is why supply-side policies matter for sustained growth.
In diagramming: always draw LRAS as a separate, labelled line (vertical or Keynesian shape). Then add SRAS crossing it. Shift one at a time to avoid confusion.