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A-Level · Macroeconomics

ECO.MAC6 Aggregate Supply: Short Run, Long Run and Supply-Side Shocks

AQA 7136 · Calculators not allowed · about 120 minutes

Total Marks

Name: _______________________________ Date: ____ / ____ / ______

Answer all questions. Use full sentences for questions worth 4 marks or more. Time guidance 120 minutes. No calculator is allowed.

Define the short-run aggregate supply (SRAS) curve in macroeconomics and explain why it is upward sloping in the short run, in the context of an advanced open economy.

Define SRAS and explain why it slopes upward in the short run for an advanced open economy.

(Total for Question 1 is 2 marks)

Define the long-run aggregate supply (LRAS) curve in the classical model and state what it represents in terms of productive capacity and full employment for a national economy.

Define LRAS and state its representation for productive capacity and full employment.

(Total for Question 2 is 2 marks)

Explain two ways in which an increase in nominal wages across an economy could shift the short-run aggregate supply (SRAS) curve. Use short-run cost reasoning.

(Total for Question 3 is 3 marks)

State two supply-side factors that would cause the long-run aggregate supply (LRAS) curve to shift to the right, increasing the economy's potential output, and name briefly why each does so.

(Total for Question 4 is 2 marks)

Explain briefly how a sudden upward spike in global oil prices acts as a cost-push shock for a small open economy and indicate the immediate effect on SRAS, the domestic price level and real output.

(Total for Question 5 is 3 marks)

Explain how a sustained improvement in total factor productivity (TFP) would affect both SRAS and LRAS, and indicate the likely time profile of these effects.

(Total for Question 6 is 3 marks)

State and briefly explain one reason why an exchange rate appreciation could shift short-run aggregate supply (SRAS) to the right in a small open economy.

(Total for Question 7 is 3 marks)

Diagram question: An economy faces a sudden industry-wide increase in minimum wages that raises labour costs for low-skilled sectors. Draw an AD/AS diagram showing SRAS and LRAS before the shock and show the correct shift(s) for SRAS and/or LRAS that follow the wage rise. Indicate the expected change in the price level and real output in the short run. (Describe what you would draw.)

Figure (to be drawn): Student should draw standard AD/AS axes: Price level vertical, Real GDP horizontal. Draw AD downward sloping, SRAS upward sloping and LRAS vertical at potential output. Mark initial equilibrium E1 at intersection of AD and SRAS with LRAS. Then show SRAS shifting left to SRAS2 (parallel or slightly steeper), new short-run equilibrium E2 at intersection of AD and SRAS2 with a higher price level and lower real output. Do not shift LRAS for an immediate wage cost shock.

(Total for Question 8 is 4 marks)

Diagram question: A government implements a long-term programme of public investment in transport and digital infrastructure expected to raise productive capacity. On an AD/AS diagram, show the effect this policy would have on LRAS and SRAS over time, and explain the likely effect on the price level and real output in the medium to long run. (Describe what you would draw.)

Figure (to be drawn): Student should draw AD downward sloping, SRAS upward sloping and LRAS vertical at potential output. Mark initial equilibrium E1. Then show LRAS shifting right to LRAS2 (indicating higher potential output). Optionally show SRAS shifting right as short-run costs fall and productivity improves. New medium/long-run equilibrium at intersection of AD and shifted LRAS (and possibly SRAS2) with higher real output and ambiguous or lower price level depending on AD position.

(Total for Question 9 is 4 marks)

Explain two reasons why short-run aggregate supply (SRAS) might be relatively flat at low levels of output but become steeper as the economy approaches potential output (LRAS).

(Total for Question 10 is 3 marks)

State two ways in which an adverse supply-side shock, such as a major drought that reduces agricultural yields, differs in its macroeconomic effects from a pure demand-side shock caused by a sudden fall in consumer confidence.

(Total for Question 11 is 3 marks)

Explain briefly how a temporary negative supply shock and a permanent reduction in productive capacity would differ in their effects on SRAS and LRAS and on policy responses.

(Total for Question 12 is 4 marks)

Evaluate the view that supply-side shocks pose a greater risk to price stability than demand-side shocks. In your answer, analyse mechanisms, consider diagrammatic evidence, weigh the role of policy responses and timing, and reach a supported judgement.

(Total for Question 13 is 25 marks)

Mark scheme · ECO.MAC6 Aggregate Supply: Short Run, Long Run and Supply-Side Shocks

Question 1

B1 SRAS is the relationship showing the level of real output firms are willing to supply at different price levels when some factor costs, such as nominal wages, are fixed in the short run
B1 it slopes upward because higher price levels raise firms revenue relative to fixed short-run costs or because higher output requires higher marginal costs, so higher prices are needed to induce more supply
Answer: SRAS shows real output supplied at different price levels when some input costs are fixed; it slopes upward because higher prices improve firms' profitability relative to fixed costs or because marginal costs rise with output.

Question 2

B1 LRAS is the relationship between the price level and real output when all factor prices and wages have fully adjusted
B1 it represents the economy's potential or full-employment level of output, determined by factor supplies and technology and independent of the price level in the classical view
Answer: LRAS shows output when factor prices have adjusted and equals the economy's potential or full-employment output determined by resources and technology.

Question 3

M1 identifies that higher nominal wages increase firms' unit labour costs
A1 explains that higher unit costs reduce profitability at each price level, so firms supply less at any given price and SRAS shifts left
A1 alternative development: higher wages may lead firms to raise prices or cut employment/production, both reducing short-run aggregate supply
Answer: Higher nominal wages raise unit labour costs and reduce profitability, so firms supply less at each price level and SRAS shifts left; firms may also pass costs into higher prices or reduce output/employment, reducing SRAS.

Question 4

B1 an increase in the size or skill of the labour force, which raises available labour input and productivity
B1 improvements in technology or higher investment in capital/infrastructure, which increase capital per worker and total factor productivity
Answer: Examples: a larger or more skilled labour force; improvements in technology or increased investment in capital/infrastructure, both raising productive capacity.

Question 5

M1 a rise in oil prices raises production and transport costs across many industries, increasing firms' unit costs
A1 this shifts SRAS left because firms supply less at each price level when costs rise
A1 the immediate effect is a higher domestic price level (cost-push inflation) and lower real output, producing stagflationary pressure in the short run
Answer: Higher oil prices raise firms' costs, shifting SRAS left, leading to a higher price level and lower real output in the short run.

Question 6

M1 a rise in TFP increases output per unit of input, lowering unit costs and raising productive capacity
A1 in the short run SRAS shifts right because firms can supply more at each price level due to lower costs
A1 in the long run LRAS shifts right as the economy's potential output increases; the LRAS effect is persistent while the SRAS shift may be an initial response followed by further supply-side gains
Answer: Higher TFP reduces unit costs and raises output per input, shifting SRAS right in the short run and shifting LRAS right in the long run as potential output increases, with LRAS effects building over time.

Question 7

M1 identifies that an appreciation makes imported inputs and intermediate goods cheaper in domestic currency terms
A1 explains that cheaper imported inputs reduce firms' production costs, increasing supply at each price level and shifting SRAS to the right
B1 alternative development: cheaper imported capital goods can raise productivity, reinforcing the rightward shift
Answer: An appreciation reduces the domestic cost of imported inputs and capital goods, lowering firms' unit costs and so shifting SRAS right as firms supply more at each price level.

Question 8

B1 correctly labels axes and initial curves AD, SRAS and LRAS and marks initial equilibrium E1
B1 shows SRAS shifting to the left (correct direction) and does NOT shift LRAS for an immediate cost shock
B1 identifies outcome: higher price level and lower real output at the new short-run equilibrium E2
B1 provides a succinct explanation linking higher minimum wages to higher unit labour costs, leftward SRAS shift and resultant stagflationary short-run effect
Answer: Draw leftward shift of SRAS, no LRAS shift; result: price level rises, real output falls.

Question 9

B1 correctly labels axes and initial curves AD, SRAS and LRAS and marks initial equilibrium E1
B1 shows LRAS shifting right to LRAS2 to represent higher potential output due to infrastructure investment
B1 shows SRAS may also shift right (or remain) as productivity and lower unit costs spread, and explains this timing difference
B1 identifies medium/long-run outcome: higher real output (potential) and, ceteris paribus, a lower or unchanged price level relative to where it would otherwise be, with explanation that increased capacity reduces inflationary pressure
Answer: Draw LRAS shifting right (and possibly SRAS right); result: higher real output and lower or stable price level in medium-long run, reducing inflationary pressure.

Question 10

M1 identifies spare capacity: when output is well below potential, there are unemployed resources and idle capital
A1 explains that firms can increase output without bidding up wages or other input prices, so SRAS is relatively flat and output rises more for a given rise in AD
A1 identifies that as capacity is used up, inputs become scarcer and marginal costs rise, so SRAS becomes steeper as further increases in AD produce more inflation than extra output
Answer: With spare capacity SRAS is flat because firms can use idle labour/capital without raising input prices; as capacity is used up inputs become scarce, marginal costs rise and SRAS steepens so AD increases cause more price rises than extra output.

Question 11

B1 adverse supply shock shifts SRAS left, causing higher prices and lower output; demand shock shifts AD left, causing lower prices and lower output
B1 supply shocks can cause stagflation (higher inflation with lower output), whereas demand shocks typically reduce both inflation and output
B1 supply shocks can be more persistent if they damage productive capacity (e.g. crop yields), while demand shocks may be more quickly reversed by policy or confidence returning
Answer: Supply shock: leftward SRAS shift, higher prices and lower output, potential stagflation and possible long-lasting capacity loss; demand shock: leftward AD shift, lower prices and lower output, usually less inflationary and often easier to counter with demand management.

Question 12

M1 states that a temporary negative supply shock shifts SRAS left but leaves LRAS unchanged
A1 explains that the temporary SRAS shift raises prices and lowers output in the short run but can reverse when the shock passes
M1 states that a permanent reduction in productive capacity shifts LRAS left (and may also shift SRAS left)
A1 explains that a leftward LRAS shift reduces potential output permanently, implying policy must focus on supply-side measures rather than demand management to restore growth
Answer: A temporary shock shifts SRAS left raising prices and lowering output temporarily while LRAS remains unchanged; a permanent capacity reduction shifts LRAS left reducing potential output and requiring supply-side policies to rebuild capacity rather than demand stimulus.

Question 13

Level 1 (1-5): Basic statements about supply-side and demand-side shocks with limited or no analysis, or a narrow explanation of one mechanism with no evaluation or diagrammatic reference.
Level 2 (6-10): Clear explanation of mechanisms by which supply-side and demand-side shocks affect price level and output, including a simple diagrammatic reference and some indication of policy responses, but limited evaluation or balance.
Level 3 (11-15): Detailed analysis of both supply-side and demand-side shocks, accurate use of AD/AS diagram(s) to show effects, discussion of the effectiveness and timing of monetary and fiscal policy, consideration of persistence and distributional effects, and a supported judgement on which is the greater risk to price stability.
Level 4 (16-20): Comprehensive, well-developed analysis including sectoral examples (e.g. oil shocks, wage-price spirals), evaluation of scenarios where each shock could dominate, nuanced discussion of lags, credibility and secondary effects, and a balanced, well-supported conclusion with reference to diagrammatic shifts and policy trade-offs.
Level 5 (21-25): Excellent evaluation: full range of analytical points, clear and correctly labelled diagrams showing multiple comparative scenarios, sophisticated appraisal of policy options (including supply-side measures and monetary policy limits), consideration of empirical relevance and time horizons, and a decisive, justified judgement recognising conditions under which the view holds or fails.
Indicative content:
- Explain how supply-side shocks (e.g. oil price spike, commodity shortages, sudden wage rises, exchange rate shocks) shift SRAS left, causing higher prices and lower output, producing stagflationary pressure.
- Diagram(s): show leftward SRAS shift with AD unchanged; show potential leftward LRAS shift for persistent capacity loss.
- Explain how demand-side shocks shift AD: positive demand shock raises price and output, negative demand shock lowers both; diagrammatically show AD shifts and contrast with SRAS shifts.
- Argue supply shocks can be harder to counter with monetary policy because raising interest rates to fight supply-driven inflation worsens output, while cutting rates to support output risks higher inflation.
- Discuss timing and persistence: supply shocks can be temporary or long-lasting; permanent capacity loss shifts LRAS and reduces potential output, implying long-term inflationary consequences if AD is not reduced.
- Consider policy options: supply-side measures (investment, training, subsidies), targeted fiscal support, and the limits of monetary policy; note lags in supply-side policy vs fast-acting demand management.
- Consider magnitude and frequency: large, economy-wide supply shocks (global oil shocks) can dominate price dynamics; small, persistent demand shocks can also destabilise prices if monetary policy is weak.
- Distributional and sectoral effects: supply shocks can hit particular sectors harder, creating second-round effects such as wage demands that amplify inflation into a wage-price spiral.
- Evaluate empirical context and credibility of policy-makers: independent central banks may prioritise price stability and thus treat demand shocks differently from supply shocks; credibility affects inflation expectations and real wages.
- Conclude with a supported judgement that recognises conditionality: supply shocks often pose a greater immediate risk to price stability because they directly raise costs and can cause stagflation, but in many contexts large demand shocks or poor policy responses can be equally or more destabilising; the final judgement should state which is greater under plausible assumptions and why.

Aggregate Supply: Short Run, Long Run and Supply-Side Shocks - Worksheets, Questions and Revision