OCR A Level Economics: Aggregate supply and the AD/AS model (H460)

This guide follows the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. It covers the area of study “Aggregate demand and aggregate supply” for the topics Aggregate supply (AS) and Aggregate demand and aggregate supply, plus the first two outcomes of Macroeconomic equilibrium. The material sits in Component 2, Macroeconomics. The specification labels no content as AS-level or A-level only, so all of it is A Level content. The countries and data below are invented purely to demonstrate technique.

Pair it with the revision notes and the practice questions. Related pages: Macroeconomics overview, the course hub, a topic checklist and the diagnostics.

What you must be able to do

Specification outcome	Section
Explain what is meant by aggregate supply	1
Distinguish the Keynesian and neo-classical approaches to AS	2
Explain the AS and price level relationship, short run and long run	1 and 2
Explain why AS may shift in the short run and long run	3
Complete, understand and interpret AD/AS diagrams	4
Understand the assumptions of the AD/AS model	5
Use the model and data to see why supply-side and/or demand-side policies may be appropriate	7
Explain macroeconomic equilibrium and how it might change	4 and 6
Evaluate, using AD/AS, effects on growth, unemployment and inflation	6

The aggregate demand curve itself, the multiplier, output gaps, the Phillips curve and the wider schools of thought are separate topics. Here AD is simply a downward-sloping curve that you can shift.

1. What aggregate supply is

Aggregate supply (AS) is the planned real output of the whole productive sector at each possible price level, over a stated period. The axes are the price level (a general price index, vertical) and real output (real GDP, horizontal).

The short-run aggregate supply (SRAS) curve slopes upwards. In the short run some costs, mainly nominal wages, are fixed by contracts. If the price level rises while costs stay put, profit per unit rises, so firms supply more. The reverse holds when the price level falls. Higher output also means overtime, less efficient machines and rising unit costs, which is why the curve steepens as capacity is approached.

The long-run aggregate supply (LRAS) curve shows the economy’s productive capacity once all costs and prices have had time to adjust. Its position depends on the quantity and quality of factors of production and on technology, not on the price level.

2. Keynesian and neo-classical approaches

The two approaches disagree about the LRAS curve and about how quickly an economy returns to full employment.

	Neo-classical	Keynesian
LRAS shape	Vertical at potential output	Can be horizontal, upward-sloping then vertical (a reverse-L shape)
Wages and prices	Flexible, so markets clear in the long run	Sticky downwards, so unemployment can last
Equilibrium	Economy gravitates to potential output	Equilibrium can sit below full employment for a long time
AD changes	Change only the price level in the long run	Change real output when there is spare capacity

A sketch of the Keynesian curve (price level up, real output across):

P |                       |
  |                      /|  <- vertical: full capacity
  |                    /  |
  |  ---------------/     <- rising: bottlenecks
  |  flat: spare capacity
  +---------------------------- Real output

Worked example 1 (invented Country B, Keynesian AS). The AS curve is flat at a price level of 100 up to real output 400, then rises (real output = 4 × price level) up to output 500 at a price level of 125, then is vertical. AD starts as real output = 560 − 2 × price level and shifts right by 40, 120 and 80 in turn.

AD curve	Equilibrium (price, output)	Change in output	Change in price
AD0: 560 − 2P	100, 360
AD1: 600 − 2P	100, 400	+11.1%	0%
AD2: 720 − 2P	120, 480	+20.0%	+20.0%
AD3: 800 − 2P	150, 500	+4.2%	+25.0%

Check AD2: 720 − 2P = 4P gives P = 120 and output 480. For AD3 the equilibrium is on the vertical section, so output is 500 and P = (800 − 500)/2 = 150. Demand boosts raise output only while there is spare capacity. Once the economy is at full capacity it raises only prices.

3. Why AS shifts

A movement along SRAS is caused by a change in the general price level. A shift comes from something else that changes costs or capacity.

Shifts SRAS (short run)	Shifts LRAS (long run)
Wage costs and labour productivity changes	Size of the labour force, through migration or participation
Raw material and energy prices	Skills and education of the workforce
Exchange rate (changes the price of imported inputs)	Capital stock and infrastructure
Taxes on firms and subsidies	Technology and innovation
Supply shocks such as bad weather or disruption	Institutions, competition and regulation

SRAS shifts right when costs fall and left when they rise. An LRAS shift is a change in potential output, so it also moves SRAS. A fall in the price of imported fuel shifts SRAS only. Investment in a new technology shifts both. Treat a change as long run only if it alters productive capacity.

4. Completing and reading an AD/AS diagram

A full diagram has labelled axes (price level, real output), downward-sloping AD, upward-sloping SRAS and a vertical LRAS at potential output (neo-classical view). Macroeconomic equilibrium is where AD meets SRAS: total planned spending equals the output firms will supply at that price level. Long-run equilibrium is where AD, SRAS and LRAS all meet.

Worked example 2 (invented Country A). AD0: output = 840 − 4P. SRAS0: output = 6P − 160. LRAS: 440.

Price level	AD0	SRAS0
80	520	320
90	480	380
100	440	440
110	400	500
120	360	560

Equilibrium: P = 100, real output 440, which is on LRAS. Now AD rises to AD1: output = 900 − 4P.

• Short run: 900 − 4P = 6P − 160, so P = 106 and output = 476. Real output rises by 36/440 = 8.18% and the price level by 6.0%. Output is 36 above potential.
• Long run: firms and workers face higher prices, so wages and costs rise and SRAS shifts left. The economy returns to output 440 on AD1, where P = (900 − 440)/4 = 115, which is 15.0% above the starting price level.

Nominal and real. Nominal GDP = price level × real output / 100. It was 440. In the short-run equilibrium it is 106 × 476 / 100 = 504.56, up 14.67%. That is (1.0818 × 1.06) − 1, so real growth plus inflation gives the nominal change.

5. Assumptions of the AD/AS model

• A single price level and a single real output represent millions of prices and products. The model hides which sectors or regions gain.
• Curves are drawn ceteris paribus. In practice AD and AS interact: higher investment raises AD now and AS later.
• SRAS is upward-sloping because input prices, especially wages, are sticky in the short run. In the neo-classical view they are flexible in the long run.
• Potential output is treated as known and stable. It is hard to measure.
• Expectations and policy are not modelled, and the model is static: it compares equilibria without showing the path or the timing between them.
• Choosing between a vertical and a Keynesian LRAS is itself an assumption about how flexible wages and prices are.

These limits matter when you evaluate. A conclusion drawn from the diagram is only as good as the assumptions behind the curves.

6. How equilibrium changes, and the effect on growth, unemployment and inflation

Unemployment is read from output: more output usually needs more labour, so unemployment tends to fall as output rises. The link is not exact because productivity, participation and the type of unemployment all matter.

Change (starting at output 440, price 100)	New equilibrium	Growth	Inflation	Unemployment
AD rises (example 2)	106, 476	+8.18%	+6.0%	Falls
SRAS shifts left, cost push: SRAS = 6P − 220	106, 416	−5.45%	+6.0%	Rises
LRAS and SRAS shift right: SRAS = 6P − 100, LRAS 464	94, 464	+5.45%	−6.0%	Falls (if workers are needed)

Check the cost-push row: 840 − 4P = 6P − 220 gives P = 106, output 416, which is 24 (5.45%) below potential. This is stagflation: lower output and higher prices together. Check the last row: 840 − 4P = 6P − 100 gives P = 94 and output 464, equal to the new potential output (464/440 = +5.45%).

Evaluation chain for any shift. Say what shifts and why, show the new equilibrium, name the effect on growth, unemployment and inflation, then judge using:

• how much spare capacity there is (the flatter the AS, the less inflation);
• whether the shift is temporary or permanent;
• time lags before costs adjust;
• size of the shock and of the multiplier;
• expectations: if workers expect higher inflation, SRAS shifts left sooner;
• the aim of government. A policy that is good for growth may harm inflation or the balance of payments.

7. Using the model to judge demand-side and supply-side policies

Read the data first, then choose the policy.

Invented economy	Output vs potential	Unemployment	Inflation
Country P	4% below	9.0%	0.5%
Country Q	3% above	3.5%	5.5%
Country R	3% below	8.0%	6.0%

• Country P: weak AD with spare capacity and little inflation risk. A rise in AD (lower interest rates, tax cuts, more public spending) moves output toward potential. This is a demand-side case.
• Country Q: AD is pushing the economy past capacity and prices are rising. Restraining AD (tighter policy) or raising capacity through supply-side measures reduces inflation.
• Country R: output low and inflation high suggests SRAS has shifted left. Raising AD would restore output at the price of still higher inflation (see practice question 10). Policies that cut costs or raise productivity attack the cause.
• Sustained growth needs LRAS to move right. Demand policy cannot do that alone, because past potential output extra AD produces only inflation. Supply-side policies (education, infrastructure, competition, tax incentives to invest) shift LRAS but act slowly and cost money.

Evaluation: demand-side policy is quick but depends on spare capacity and can be inflationary. Supply-side policy is durable but slow, uncertain and often costly. Many economies use both.

Common errors

• Shifting AD or AS when only the price level has changed. A price change is a movement along.
• Drawing LRAS sloping upwards and calling it neo-classical. The neo-classical LRAS is vertical.
• Calling any cost fall long run. Only changes in capacity shift LRAS.
• Forgetting to label the new equilibrium on both axes, or to compare it with the old one.
• Writing “inflation falls” when only the rate of increase in prices has slowed.
• Using the model without naming an assumption when you evaluate.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021, area of study “Aggregate demand and aggregate supply”: topics Aggregate supply (AS); Aggregate demand and aggregate supply; and the first two outcomes of Macroeconomic equilibrium.