Introduction

The Aggregate Supply (AS) curve shows the total quantity of goods and services that all firms in an economy are willing and able to produce at different price levels. Understanding aggregate supply requires a crucial distinction: the behaviour of the economy differs significantly in the short run versus the long run, and these two time horizons gave rise to two major schools of macroeconomic thought — Classical economics and Keynesian economics.

The Long-Run Aggregate Supply Curve (LRAS)

The Long-Run Aggregate Supply (LRAS) curve is rooted in Classical economics — the school of thought dominant before the Great Depression of the 1930s. Classical economists believed that market economies are self-regulating: prices, wages, and interest rates adjust freely and quickly to restore the economy to its natural level of output.

Key Classical Assumptions

• Wages and prices are fully flexible — they adjust rapidly to changes in demand and supply
• The economy automatically tends towards full employment — the natural rate of output (Y*)
• Money is neutral — changes in the money supply only affect prices, not real output (classical dichotomy)
• Markets clear without government intervention

Shape of the LRAS Curve

In the long run, output is determined entirely by real factors — the quantity and quality of labour, capital, technology, and natural resources — not by the price level. Because prices and wages are fully flexible in the long run, the economy always returns to its potential (full-employment) output Y*, regardless of the price level.

Therefore, the LRAS curve is vertical, drawn at the economy’s potential output Y*:

LRAS is vertical at Y = Y* (potential output / natural rate of output)

A rise in the price level does not increase long-run output — firms cannot sustainably produce beyond their capacity. Workers will demand higher wages to compensate for higher prices, raising costs and bringing output back to Y*.

What Shifts the LRAS?

The LRAS shifts only when the economy’s productive capacity changes:

• Technological progress — improves productivity, shifting LRAS right
• Growth in the labour force — more workers expand potential output
• Increase in physical capital — more factories and machinery raise capacity
• Improvement in human capital — better education and skills
• Discovery of natural resources — expands the production frontier

The Short-Run Aggregate Supply Curve (SRAS)

The Short-Run Aggregate Supply (SRAS) curve is based on Keynesian economics, developed by John Maynard Keynes in the aftermath of the Great Depression. Keynes observed that wages and prices do not adjust instantly — they are “sticky” in the short run. This stickiness means that in the short run, the price level does affect real output.

Why are Wages and Prices Sticky in the Short Run?

• Wage contracts: Many workers have fixed-term wage contracts that cannot be renegotiated immediately
• Menu costs: Changing prices has costs (reprinting menus, updating systems), so firms don’t adjust immediately
• Efficiency wages: Firms may resist cutting wages to maintain worker morale and productivity
• Imperfect information: Producers may not immediately distinguish between relative price changes and general price level changes

Shape of the SRAS Curve

Because input costs (especially wages) are fixed in the short run, a rise in the price level makes production more profitable. Firms respond by increasing output. Conversely, a fall in the price level reduces profitability, and firms cut output. This produces an upward-sloping SRAS curve.

SRAS slopes upward: higher prices → higher output (in the short run)

What Shifts the SRAS?

• Change in input costs — e.g., a rise in oil prices shifts SRAS left (stagflation); a fall shifts it right
• Change in wages — unexpected wage increases raise production costs, shifting SRAS left
• Supply shocks — natural disasters or geopolitical events (e.g., an oil embargo) shift SRAS left
• Change in producer expectations — if firms expect higher future prices, they may reduce current supply

Comparing LRAS and SRAS

Short-Run to Long-Run Adjustment

How does the economy move from a short-run position back to the long-run equilibrium? Suppose a fall in aggregate demand pushes the economy below Y* (a recessionary gap). In the short run, output falls and unemployment rises.

In the long run, rising unemployment puts downward pressure on wages. As wages fall, production costs decline, and the SRAS shifts rightward, restoring output to Y* at a lower price level. This self-correcting mechanism is the Classical argument against government intervention.

Keynes famously questioned this adjustment by noting: “In the long run, we are all dead.” He argued that the adjustment could take years, causing enormous suffering, and that government fiscal policy should intervene to restore output faster.

Policy Implications

• Classical/monetarist view: Government intervention is unnecessary and potentially harmful. The economy self-corrects to Y* via flexible wages and prices. Focus should be on supply-side reforms to shift LRAS rightward.
• Keynesian view: Sticky wages mean the economy can be stuck in recession for a prolonged period. Government spending or tax cuts (shifts in aggregate demand) can restore output to Y* more quickly.

Summary

The LRAS is vertical at potential output Y* because in the long run, wages and prices are fully flexible and output is determined only by real productive capacity. The SRAS is upward sloping because in the short run, wages and prices are sticky, so a higher price level boosts short-run output. The transition from short-run to long-run equilibrium occurs as wages and prices gradually adjust — a process that forms the heart of the debate between Classical and Keynesian macroeconomics.