In 1973, oil prices quadrupled in months. Factories, truckers, and airlines watched their costs explode — and the U.S. economy delivered something the textbooks of the day said couldn't happen: rising prices and rising unemployment at the same time. No demand-side story can produce that combination. You need the second curve: short-run aggregate supply, the economy's production response to the price level, built on a quirk of reality — wages and many prices are sticky, renegotiated slowly, locked in contracts. SRAS is where cost shocks, productivity booms, and expectation shifts enter the model, and it's the curve that makes stagflation possible.
Short-run aggregate supply shows the total quantity of goods and services firms produce at each price level, in the period during which input prices — especially wages — are fixed or sticky. That stickiness defines the macro short run: output prices can move while input costs lag.
Suppose the price level rises while wages are stuck at last year's contract:
Higher PL → more output supplied: upward slope. This is a movement along SRAS — the price level did it.
Anything that changes production costs or productivity at every price level shifts the entire curve. Rightward (increase in SRAS) = producing any output is cheaper; leftward (decrease) = costlier.
| Shifter | SRAS right (costs ↓) | SRAS left (costs ↑) |
|---|---|---|
| Input/resource prices (wages, energy, raw materials) | Oil prices fall; wages fall | Oil spike; economy-wide wage hikes |
| Productivity/technology | Better tech → more output per input | Productivity collapse |
| Business taxes/subsidies/regulation | Subsidies, deregulation | Per-unit taxes, costly regulation |
| Inflation expectations | Expected inflation falls → moderate wage demands | Expected inflation rises → workers demand higher wages now |
| Supply shocks | Positive (bumper harvest) | Negative (war, embargo, disaster, pandemic) |
Expectations deserve a highlight: they're the shifter that makes Lesson 13's long-run adjustment work. If everyone expects 6% inflation, wage bargains build it in, costs rise, SRAS shifts left even with no real shock at all.
Apply It: Classify each: (1) The minimum wage rises nationwide. (2) AI tools raise output per worker across services. (3) The price level rises 2%. (4) A drought destroys half the grain crop. → (1) SRAS left; (2) SRAS right; (3) movement along SRAS; (4) SRAS left (negative supply shock).
A negative supply shock (SRAS left) raises the price level while cutting output — inflation plus recession: stagflation. Demand policy then faces a cruel menu: stimulate AD and worsen inflation, or fight inflation and deepen the recession. Recognizing "this is a supply shock, not a demand slump" is one of the highest-value skills on the FRQ — the fix isn't symmetric, and the exam knows students default to demand-side stories.
(Where's the long-run supply curve? Lesson 7. It's vertical, it lives at full employment, and it turns today's sticky-wage story into a temporary one.)
[GRAPH: Short-Run Aggregate Supply
X-axis: Real GDP (Y)
Y-axis: Price level (PL)
Curve 1: SRAS, upward-sloping, labeled SRAS₁
Reading: PL rises from 100 to 105 with wages fixed → profit margins widen →
output supplied rises — a movement ALONG SRAS₁
Shift: world oil prices double → production costs rise at EVERY price level →
SRAS shifts LEFT to SRAS₂ → at any given PL, less output supplied]
[GRAPH: Negative supply shock previewed with AD (stagflation)
X-axis: Real GDP (Y)
Y-axis: Price level (PL)
Curve 1: AD, downward-sloping, fixed
Curve 2: SRAS₁ shifting left to SRAS₂
Equilibrium: moves from (Y₁, PL₁) up-left to (Y₂ < Y₁, PL₂ > PL₁)
Effect: output falls AND the price level rises — stagflation]
AP labeling requirements: axes PL and Real GDP; curves labeled SRAS₁ → SRAS₂ with an arrow; when AD is on the graph, mark both equilibria with dashed lines to both axes. The stagflation direction (up and to the left along AD) is a favorite "which graph shows…" target.
1. B. Sticky input costs + rising output prices = fatter margins = more production. A: the wealth effect belongs to AD's slope. C: the money supply is policy-set. D: "matching demand" isn't a supply mechanism. E: if input prices rose instantly, SRAS would be vertical — stickiness is the whole point.
Fix: SRAS slopes up because output prices outrun sticky input prices in the short run.
2. E. The defining feature: wages/input prices lag output prices. A: full flexibility defines the long run. B: money supply isn't part of the definition. C: real GDP changes constantly in the short run. D: entry/exit is a micro long-run marker.
Fix: Macro short run = sticky input prices; macro long run = all prices flexible.
3. C. Price level is the y-axis variable → movement along. A/B/D/E: wages, oil, technology, and production taxes all change costs → shifts.
Fix: Only the price level moves you along SRAS; costs and capability move the curve.
4. A. Energy is a near-universal input; tripled costs → less supplied at every PL → SRAS left (price level up, output down once AD is considered). B: conservation doesn't reverse a cost explosion. C: the first-order event is a cost shock, not a spending shock. D: no initiating PL change. E: imported inputs still enter domestic production costs.
Fix: Input-price shocks — oil above all — are SRAS shifters, direction opposite the cost change.
5. D. More output per worker = lower unit cost = SRAS right. A: productivity gains expand supply even if labor is displaced. B: productivity shifts both SRAS and LRAS. C: verticality is LRAS's property. E: no wage rise is described.
Fix: Productivity up → costs per unit down → SRAS (and LRAS) right.
6. C. Expected inflation → higher wage demands now → higher costs → SRAS left. A: expectations of inflation typically accelerate purchases if anything, and that's not the tested channel. B: no actual PL change yet. D: backwards. E: expectations act through today's wage bargains — no waiting.
Fix: Inflation expectations are a cost shifter: they move SRAS left before any actual inflation shows up.
7. A. Only SRAS-left produces the up-left combination (PL↑, Y↓). B: AD right raises both. C: AD left lowers both. D: SRAS right is the happy opposite. E: movements along don't change equilibrium by themselves.
Fix: Opposite moves in PL and Y = supply story; same-direction moves = demand story.
8. E. Cutting per-unit production taxes lowers costs at every PL → SRAS right. A/B/C: all raise costs → left. D: transfers work on AD through C.
Fix: For SRAS, follow unit production costs — down = right, up = left.
9. B. Falling output prices against contract-fixed wages squeeze margins → cut output: the downward movement along SRAS. A: real wages rose (same nominal wage, lower prices) — costlier labor, not cheaper. C: nothing shifted; the PL moved. D: irrelevant mechanism. E: the whole point of stickiness is that effects occur before contracts expire.
Fix: Deflation with sticky wages = margin squeeze = slide down SRAS.
10. D. Negative supply shock = SRAS left, sliding up a fixed AD: PL↑, Y↓. A: that's a demand collapse (both fall). B: that's a positive shock. C: demand boom. E: unrelated combination.
Fix: For "which graph" questions, first decide which curve moved, then check both equilibrium directions match the story.
11. C. Drought → SRAS left (PL↑, Y↓); confidence → AD right (PL↑, Y↑). Price level: both push up → rises. Output: forces conflict → indeterminate. A/B: pick one force and ignore the other. D: PL is the determinate one. E: only output is indeterminate.
Fix: With double shifts, tally each variable separately: agreement = determinate, conflict = indeterminate.
12. A. Wages are the dominant input price; an economy-wide 8% rise lifts unit labor costs at every PL → SRAS left. B: no initiating price-level change. C: the exam channels wage shocks through costs unless it explicitly asks about income effects. D: better-paid ≠ cheaper production. E: LRAS moves with resources/technology, not nominal wages.
Fix: Nominal wage changes are the canonical SRAS shifter — left when wages rise.
13. E. Cost changes relocate the whole curve; the resulting equilibrium PL change is an outcome, not a cause of movement along the original SRAS. A: reverses cause and effect. B: wrong curve. C: no such carve-out. D: rotation isn't a thing here.
Fix: Never let a shift masquerade as a movement: identify what initiated the change — PL (move) or costs (shift).
The economy of Norvale is initially operating with stable prices. Then a prolonged conflict abroad triples the price of imported oil, a critical input for Norvale's manufacturing and transportation sectors.
(a) Draw a correctly labeled aggregate demand–short-run aggregate supply graph for Norvale showing the initial equilibrium price level PL₁ and output Y₁, and the effects of the oil shock. Label the new equilibrium PL₂ and Y₂.
(b) Based on your graph, state what happens to (i) the price level and (ii) real output. What is this combination called?
(c) Explain the mechanism by which the oil price increase changes short-run aggregate supply, referencing production costs.
(d) Norvale's unemployment rate was at the natural rate before the shock. After the shock, is cyclical unemployment positive, negative, or zero? Explain.
(e) A policymaker proposes stimulating aggregate demand to restore output to Y₁. Identify one drawback of this proposal, using your graph.
1. B. Sticky input costs + rising output prices = fatter margins = more production. A: the wealth effect belongs to AD's slope. C: the money supply is policy-set. D: "matching demand" isn't a supply mechanism. E: if input prices rose instantly, SRAS would be vertical — stickiness is the whole point. Fix: SRAS slopes up because output prices outrun sticky input prices in the short run.
2. E. The defining feature: wages/input prices lag output prices. A: full flexibility defines the long run. B: money supply isn't part of the definition. C: real GDP changes constantly in the short run. D: entry/exit is a micro long-run marker. Fix: Macro short run = sticky input prices; macro long run = all prices flexible.
3. C. Price level is the y-axis variable → movement along. A/B/D/E: wages, oil, technology, and production taxes all change costs → shifts. Fix: Only the price level moves you along SRAS; costs and capability move the curve.
4. A. Energy is a near-universal input; tripled costs → less supplied at every PL → SRAS left (price level up, output down once AD is considered). B: conservation doesn't reverse a cost explosion. C: the first-order event is a cost shock, not a spending shock. D: no initiating PL change. E: imported inputs still enter domestic production costs. Fix: Input-price shocks — oil above all — are SRAS shifters, direction opposite the cost change.
5. D. More output per worker = lower unit cost = SRAS right. A: productivity gains expand supply even if labor is displaced. B: productivity shifts both SRAS and LRAS. C: verticality is LRAS's property. E: no wage rise is described. Fix: Productivity up → costs per unit down → SRAS (and LRAS) right.
6. C. Expected inflation → higher wage demands now → higher costs → SRAS left. A: expectations of inflation typically accelerate purchases if anything, and that's not the tested channel. B: no actual PL change yet. D: backwards. E: expectations act through today's wage bargains — no waiting. Fix: Inflation expectations are a cost shifter: they move SRAS left before any actual inflation shows up.
7. A. Only SRAS-left produces the up-left combination (PL↑, Y↓). B: AD right raises both. C: AD left lowers both. D: SRAS right is the happy opposite. E: movements along don't change equilibrium by themselves. Fix: Opposite moves in PL and Y = supply story; same-direction moves = demand story.
8. E. Cutting per-unit production taxes lowers costs at every PL → SRAS right. A/B/C: all raise costs → left. D: transfers work on AD through C. Fix: For SRAS, follow unit production costs — down = right, up = left.
9. B. Falling output prices against contract-fixed wages squeeze margins → cut output: the downward movement along SRAS. A: real wages rose (same nominal wage, lower prices) — costlier labor, not cheaper. C: nothing shifted; the PL moved. D: irrelevant mechanism. E: the whole point of stickiness is that effects occur before contracts expire. Fix: Deflation with sticky wages = margin squeeze = slide down SRAS.
10. D. Negative supply shock = SRAS left, sliding up a fixed AD: PL↑, Y↓. A: that's a demand collapse (both fall). B: that's a positive shock. C: demand boom. E: unrelated combination. Fix: For "which graph" questions, first decide which curve moved, then check both equilibrium directions match the story.
11. C. Drought → SRAS left (PL↑, Y↓); confidence → AD right (PL↑, Y↑). Price level: both push up → rises. Output: forces conflict → indeterminate. A/B: pick one force and ignore the other. D: PL is the determinate one. E: only output is indeterminate. Fix: With double shifts, tally each variable separately: agreement = determinate, conflict = indeterminate.
12. A. Wages are the dominant input price; an economy-wide 8% rise lifts unit labor costs at every PL → SRAS left. B: no initiating price-level change. C: the exam channels wage shocks through costs unless it explicitly asks about income effects. D: better-paid ≠ cheaper production. E: LRAS moves with resources/technology, not nominal wages. Fix: Nominal wage changes are the canonical SRAS shifter — left when wages rise.
13. E. Cost changes relocate the whole curve; the resulting equilibrium PL change is an outcome, not a cause of movement along the original SRAS. A: reverses cause and effect. B: wrong curve. C: no such carve-out. D: rotation isn't a thing here. Fix: Never let a shift masquerade as a movement: identify what initiated the change — PL (move) or costs (shift).
Exam tip: SRAS questions hinge on one sorting decision — spending or costs? — followed by one direction call. Keep a two-line cheat in your head: costs ↑ → SRAS ←; costs ↓ → SRAS →. And when a question pairs falling output with rising prices, don't fight it: that's your supply shock. Next lesson the model gets its third curve — the vertical one — and gaps become drawable.