SRAS, LRAS & the Role of Sticky Wages

You’ll be able to

Explain why short-run aggregate supply slopes upward
Explain why long-run aggregate supply is vertical at potential output
Distinguish what shifts SRAS from what shifts LRAS

SRAS slopes up because some prices are stuck

In the short run, nominal wages and many input prices are sticky — fixed by contracts, convention or slow renegotiation. So when output prices rise, firms' costs do not rise with them, profit margins widen, and producing more becomes attractive. That is the upward slope. Everything about SRAS depends on this stickiness: remove it and the curve is vertical, which is precisely what happens in the long run.

LRAS is vertical because eventually nothing is stuck

Given enough time, wages and input prices adjust fully to the price level. Doubling all prices and all wages leaves every real incentive exactly where it was, so firms produce the same real output. Output in the long run is set by real things — labor force, capital stock, technology, institutions — and not at all by the price level. Hence a vertical LRAS at potential output, which is also the level consistent with unemployment at its natural rate.

What shifts what

SRAS shifts: input prices, nominal wages, supply shocks, productivity, inflation expectations · LRAS shifts: labor force, capital stock, technology, institutions

Anything that changes real productive capacity shifts BOTH. Anything that only changes costs shifts SRAS alone.

The overlap that decides free-response answers

Technology and productivity improvements shift both curves right — they lower costs now and raise capacity permanently. A change in oil prices shifts SRAS only, because capacity is unaffected. Immigration or capital investment shifts LRAS and, through capacity, SRAS with it. Getting this split right is what separates a full-credit AD–AS answer from a partial one, because the exam picks shocks specifically to test whether you shift one curve or two.

Worked example

An economy at long-run equilibrium experiences a permanent technological breakthrough that raises productivity across all industries. Show the effect on both supply curves, output and the price level.

1.Higher productivity lowers unit costs now, so SRAS shifts right.
2.It also raises the economy's sustainable capacity, so LRAS shifts right too.
3.With AD unchanged, the rightward supply shifts raise real output.
4.Both curves shifting right along a fixed AD lowers the price level.

Answer: Both SRAS and LRAS shift right; real output rises and the price level falls. Potential output is now permanently higher, which is the distinguishing feature of a supply improvement over a demand stimulus.

Watch out

A change in the price level never shifts SRAS — the price level is the axis. And a change in AD never shifts SRAS directly; it moves the economy along SRAS. Only later, through wage adjustment, does SRAS itself move.

Checkpoint

Long-run aggregate supply is vertical because in the long run:

Checkpoint

A large increase in the price of imported oil shifts:

Checkpoint

Which would shift LRAS to the right?

On the exam

Draw LRAS as a vertical line first, before AD and SRAS. It anchors potential output on your diagram and makes the output gap visible, which most of the later parts of the question will depend on.

Answer the 3 checkpoints as you read.