Keynesian and Classical Aggregate Supply

• The classical view is that the long run aggregate supply curve is vertical.
• The Keynesian view is that the long run aggregate supply curve takes an L shape with horizontal, upward sloping, and vertical sections.
• Keynes argued that wages are sticky downwards, making it unrealistic to expect wages to adjust in response to changes in aggregate demand.

The classical view states that the long-run aggregate supply curve is vertical. According to classical economists, a shift in aggregate demand would result in a movement along the short-run aggregate supply curve to a new equilibrium with lower prices and output. This decrease in aggregate demand leads to lower inflation, real GDP, and employment levels. Over time, high unemployment rates put downward pressure on wages, which increases the quantity of labor demanded and brings the economy back to full employment. The Keynesian view, however, argues that the long-run aggregate supply curve takes a backwards L shape with horizontal, upward sloping, and vertical sections. Keynes believed that wages are sticky downwards, meaning workers with contracts would not easily accept lower wages due to a decrease in aggregate demand. Trade unions, collective bargaining, and minimum wage legislation further complicate this adjustment process. Under the Keynesian model, a decrease in aggregate demand can lead to a long-run equilibrium at a lower level of real GDP than the full employment level. The horizontal section of the curve occurs when output is very low and resources are underutilized, allowing for an expansion of output without increasing the price level. As scarcity increases, the curve becomes upward sloping, and the trade-off between real GDP growth and inflation control returns. The long-run aggregate supply curve becomes vertical when the economy is operating at its full productive potential.