The Aggregate-Supply Curve

Why the Short-Run Aggregate-Supply Curve Might Shift

short-run aggregate-supply curve

The short-run aggregate-supply curve tells us the quantity of goods and services supplied in the short run for any given level of prices.

This curve is similar to the long-run aggregate-supply curve, but it is upward-sloping rather than vertical because of sticky wages, sticky prices, and misperceptions. Thus, when thinking about what shifts the short-run aggregate-supply curve, we have to consider all those variables that shift the long-run aggregate-supply curve. In addition, we have to consider a new variable—the expected price level—that influences the wages that are stuck, the prices that are stuck, and the perceptions about relative prices that may be flawed.

Let’s start with what we know about the long-run aggregate-supply curve. As we discussed earlier, shifts in the long-run aggregate-supply curve normally arise from changes in labor, capital, natural resources, or technological knowledge.

These same variables shift the short-run aggregate-supply curve. For example, when an increase in the economy’s capital stock increases productivity, the economy is able to produce more output, so both the long-run and short-run aggregate-supply curves shift to the right.

When an increase in the minimum wage raises the natural rate of unemployment, the economy has fewer employed workers and thus produces less output, so both the long-run and short-run aggregate-supply curves shift to the left.

The important new variable that affects the position of the short-run aggregate-supply curve is the price level that people expected to prevail.

As we have discussed earlier Opens in new window, the quantity of goods and services supplied depends, in the short run, on sticky wages, sticky prices, and misperceptions. Yet wages, prices, and perceptions are set based on the expected price level. So when people change their expectations of the price level, the short-run aggregate-supply curve shifts.

To make this idea more concrete, let’s consider a specific theory of aggregate—the sticky-wage theory Opens in new window.

According to the sticky-wage theory Opens in new window, when workers and firms expect the price level to be high, they are likely to reach a bargain with a higher level of nominal wages.

Higher wages raise firms’ costs, and for any given actual price level, higher costs reduce the quantity of goods and services supplied. Thus, when the expected price level rises, wages are higher, costs increase, and firms produce a smaller quantity of goods and services at any given actual price level.

Thus, the short-run aggregate-supply curve shifts to the left. Conversely, when the expected price level falls, wages are lower, costs decline, firms increase output at any given price level, and the short-run aggregate-supply curve shifts to the right.

A similar logic applies in each theory of aggregate supply. The general lesson is the following:

An increase in the expected price level reduces the quantity of goods and services supplied and shifts the short-run aggregate-supply curve to the left. A decrease in the expected price level raises the quantity of goods and services supplied and shifts the short-run aggregate-supply curve to the right.

As we will see in the next post Opens in new window, the influence of expectations on the positon of the short-run aggregate-supply curve plays a key role in explaining how the economy makes the transition from the short run to the long run.

In the short run, expectations are fixed and the economy finds itself at the intersection of the aggregate-demand curve and the short-run aggregate-supply curve.

In the long run, if people observe that the price level is different from what they expected, their expectations adjust and the short-run aggregate-supply curve shifts.

This shift ensures that the economy eventually finds itself at the intersection of the aggregate-demand curve and the long-run aggregate-supply curve.

You should now have some understanding about why the short-run aggregate-supply curve slopes upward and what events and policies can cause this curve to shift.