Classical and Keynesian Views of Aggregate Supply

Aggregate supply is the economic model used by neo-classical economists, since 18th and 19th Century economists did not use supply and demand models. According to classical economists, the market is competitive and efficient and will adjust rapidly whenever there is a shortage or surplus. This adjustment means that prices and wages will change quickly and easily to ensure full employment. In other words, a perfectly competitive market will return to equilibrium (natural rate of unemployment) (1). The aggregate supply curve is a straight vertical line at full-employment and is the potential GDP (2). According to classical economists, the only way to experience economic growth is to increase potential GDP. Increases in aggregate demand only lead to inflation.

From a Keynesian view, aggregate supply is a horizontal line at the prevailing price level. Keynesian economists believe that the market is not very competitive because of unions and large corporations. As a result, wages are "sticky". Therefore, changes in aggregate demand have little impact on the price level (3). During a recessionary gap, wage levels do not drop and therefore, aggregate supply would remain unchanged. Changes in aggregate demand affect price level only if the economy is at its full employment level (4). But without government intervention, there is nothing to guarantee that the economy will ever be at full employment (5).

(1) Stephanie Powers, "Aggregate Demand and Supply" (lecture, Red Deer College, Red Deer, AB, March 19, 2012).
(2) John E. Sayre and Alan J. Morris, Principles of Macroeconomics, 6th Canadian Ed. (Toronto: McGraw-Hill Ryerson Limited, 2009), 184-85.
(3) John E. Sayre and Alan J. Morris, Principles of Macroeconomics, 6th Canadian Ed. (Toronto: McGraw-Hill Ryerson Limited, 2009), 185.
(4) John E. Sayre and Alan J. Morris, Principles of Macroeconomics, 6th Canadian Ed. (Toronto: McGraw-Hill Ryerson Limited, 2009), 185.