Aggregate Demand is half of the model. The other half is supply: how much real GDP firms produce at each price level. Its shifters echo the shifters of supply for one good, now for the whole economy.
Key idea
Short-run aggregate supply (SRAS) slopes up: a higher price level brings more output in the short run, because wages and some other input prices are slow to change. SRAS shifts with production costs: nominal wages, energy and other input prices, productivity, business taxes and subsidies, and supply shocks.
Why it works
Many costs are fixed in the short run by contracts and habit: wages are set for a year, rent for a lease. If the prices firms sell at rise while those costs stay put, each extra unit becomes more profitable, so firms produce more: an upward slope. When a cost itself changes, firms need a different price level to produce any given output, so the whole curve moves. Higher oil prices move SRAS up and to the left: at every price level, less output. That is a decrease in SRAS, even though the curve moved "up."
Worked examples
Worked example: Shift or movement?
What happens to SRAS? (a) Nominal wages rise across the economy. (b) The price level rises while wages stay fixed. (c) A new technology lowers costs in many industries.
- (a) A cost rises: SRAS shifts left (a decrease).
- (b) The price level is on the axis: a movement up along SRAS.
- (c) Lower costs per unit: SRAS shifts right (an increase).
Answer: (a) left; (b) movement along; (c) right
Worked example: Reading the shift
After a drought, the SRAS curve moves up by 5 price-level points at every output. Is that an increase or a decrease in SRAS?
- Read the shift sideways: at any given price level, firms now produce less.
- So it is a decrease, a shift to the left.
Answer: A decrease
Common mistake
Shifting SRAS when the price level changes, or calling higher input costs an "increase" in SRAS because the curve moves up. A price-level change is a movement along SRAS, and higher costs mean less output at each price level: a decrease. Check: read supply shifts horizontally.