Aggregate Supply Curves Explained: From Classical to Keynesian Models

Understanding the aggregate supply (AS) curve is essential for analyzing macroeconomic performance and policy. The a supply curve represents the total quantity of goods and services that firms in an economy are willing and able to produce at different price levels, holding other factors constant.

Its shape and behavior, however, vary significantly depending on the economic model used—primarily the Classical and Keynesian frameworks. This article explores these perspectives, highlighting the evolution of economic thought regarding aggregate supply.

Classical Aggregate Supply Curve

The Classical model, rooted in the ideas of economists like Adam Smith, David Ricardo, and John Stuart Mill, dominated economic thought until the 1930s. Classical economics assumes that markets are flexible and self-correcting, and that prices, including wages, adjust to ensure full employment of resources.

In this model, the aggregate supply curve is typically portrayed as vertical at the full employment level of output (Yf). This vertical AS curve reflects the Classical belief that the economy naturally operates at its potential output in the long run. According to Classical theory, any change in the price level does not affect real output because resources are fully employed. Instead, price changes only influence nominal variables, such as wages and prices of goods, leaving real output unchanged.

Key Characteristics of the Classical AS Curve:

1. Vertical Shape: The economy’s output is determined by factors such as labor, capital, technology, and natural resources, not the price level.
2. Long-Run Perspective: The Classical AS focuses on long-run production capacity. Short-term fluctuations are seen as temporary deviations that self-correct through flexible prices.
3. Price and Wage Flexibility: Any excess demand or supply in labor or goods markets is resolved through adjustments in wages and prices, returning the economy to full employment.

The Classical view implies that fiscal policy—such as increased government spending—does not influence real output in the long run. It may raise the price level, leading to inflation, but the total quantity of goods and services produced remains anchored at the economy’s potential output. Monetary policy, similarly, affects nominal variables like money supply and prices, but not real output.

Keynesian Aggregate Supply Curve

The Keynesian model, proposed by John Maynard Keynes during the Great Depression, emerged as a response to the limitations of Classical economics. Keynes observed that economies could remain below full employment for extended periods due to insufficient aggregate demand. Unlike the vertical Classical AS curve, the Keynesian AS curve is upward sloping or even horizontal in the short run, reflecting the possibility of unused capacity and rigidities in wages and prices.

Short-Run Keynesian AS Curve

In the short run, many prices, especially wages, are sticky—they do not adjust immediately to changes in demand. Firms may respond to higher demand not by raising prices proportionately, but by increasing output, hiring more workers, or utilizing idle resources. This creates a positively sloped AS curve in the short run:

• Horizontal Segment (Below Full Employment): At low levels of output, the economy has significant idle resources. Firms can increase production without raising prices, leading to a horizontal AS curve segment.
• Upward Sloping Segment (Approaching Full Employment): As resources become scarcer, increasing output requires higher wages and prices, resulting in an upward-sloping AS curve.
• Vertical Segment (Full Employment): Once the economy reaches potential output, any further increase in demand only raises the price level without increasing real output.

Key Implications of the Keynesian AS Curve:

1. Active Fiscal Policy: Government spending and taxation can influence real output, especially when the economy operates below full employment.
2. Short-Run Output Variability: Prices and wages are not fully flexible, meaning that the economy can experience prolonged periods of unemployment or underutilized resources.
3. Demand-Driven Economy: Aggregate demand determines output in the short run, contrasting with the Classical focus on supply-driven output.

Comparing Classical and Keynesian Models

The primary difference between the Classical and Keynesian AS curves lies in flexibility and the role of prices:

In essence, the Classical model is supply-constrained and assumes the economy self-corrects, while the Keynesian model is demand-constrained in the short run and highlights the potential for market failure.

Transition from Short-Run to Long-Run AS

Modern macroeconomics often combines the insights of both schools. The short-run AS (SRAS) reflects Keynesian principles, with price and wage rigidity leading to an upward-sloping curve. In contrast, the long-run AS (LRAS) reflects Classical assumptions, vertical at potential output, as prices and wages eventually adjust.

Graphically, the economy moves along the SRAS curve in response to demand shocks. Over time, if prices and wages adjust, the SRAS shifts, and the economy gravitates toward the LRAS level of output. This synthesis allows economists to analyze both short-term fluctuations and long-term growth trends.

Determinants of Aggregate Supply

Both Classical and Keynesian models recognize that certain factors shift the AS curve:

1. Labor Force Changes: Growth in the workforce shifts AS to the right.
2. Capital Stock and Investment: Increased machinery and infrastructure boost productive capacity.
3. Technological Progress: Enhancements in productivity shift the AS curve outward.
4. Natural Resources: Discovery or depletion of resources can impact aggregate supply.
5. Government Policies: Taxes, subsidies, and regulations can affect production costs, influencing AS.

While these determinants impact both short-run and long-run AS, the short-run curve is also sensitive to temporary factors like supply shocks, wage contracts, and resource utilization.

Conclusion

The aggregate supply curve is a cornerstone of macroeconomic theory, illustrating how output responds to price changes. Classical and Keynesian models offer complementary perspectives: the Classical AS curve emphasizes long-run equilibrium and supply-side factors, while the Keynesian AS curve highlights short-run demand-driven fluctuations and the reality of wage and price rigidities.

Modern macroeconomics integrates these views, recognizing that the economy may be demand-constrained in the short run but ultimately returns to potential output in the long run.