What will be the shape of the aggregate supply curve in the Classical and Keynesian models ? Give detailed explanation.

The Classical Model and the Aggregate Supply Curve

The Classical economists, like Adam Smith and David Ricardo, believed in the self-regulating nature of markets. They assumed that wages and prices are perfectly flexible, adjusting quickly to changes in supply and demand. This flexibility is central to understanding the shape of the AS curve in the Classical model.

• Shape of the AS Curve: The AS curve in the Classical model is vertical at the level of full employment output (Yf). This implies that the economy always operates at its potential output level, regardless of the price level.
• Reasoning: Because wages and prices adjust instantaneously, any increase in aggregate demand (AD) will lead to an increase in prices but no change in real output. Workers will demand higher wages to compensate for the higher cost of living, and firms will pass these costs on to consumers in the form of higher prices.
• Role of Money: Classical economists viewed money as neutral – changes in the money supply only affect the price level, not real variables like output and employment.
• Equation: The Classical AS curve can be represented as: Y = Yf (where Y is real GDP and Yf is full employment GDP).

The Keynesian Model and the Aggregate Supply Curve

Keynesian economics, developed by John Maynard Keynes in response to the Great Depression, challenged the Classical assumptions. Keynes argued that wages and prices are ‘sticky’ – they do not adjust quickly to changes in demand, especially downwards. This stickiness is a key feature of the Keynesian AS curve.

• Shape of the AS Curve: The AS curve in the Keynesian model is initially relatively flat (elastic) at low levels of output and gradually becomes steeper (inelastic) as the economy approaches full employment. This creates a short-run AS (SRAS) curve.
• Reasoning: At low levels of output, there is significant unused capacity in the economy, and firms are willing to increase output in response to even small increases in AD. However, as output approaches full employment, firms face capacity constraints and labor shortages, leading to higher costs and requiring larger price increases to induce further output increases.
• Role of Wages: Keynes emphasized the role of nominal wage rigidity. Labor contracts, minimum wage laws, and social norms prevent wages from falling easily, even during recessions.
• Long-Run AS Curve: In the long run, Keynesians also acknowledge a vertical AS curve at the full employment level of output, similar to the Classical model. However, the short-run AS curve is the focus of Keynesian analysis.

Comparison of Classical and Keynesian AS Curves

The following table summarizes the key differences between the Classical and Keynesian AS curves:

Feature	Classical Model	Keynesian Model (Short-Run)
Shape of AS Curve	Vertical	Initially flat, then steeper
Wage & Price Flexibility	Perfectly Flexible	Sticky (especially downwards)
Impact of AD Increase	Price Increase Only	Output & Price Increase
Role of Government	Minimal Intervention	Active Intervention to Stabilize Demand
Focus	Long-Run Equilibrium	Short-Run Fluctuations

The differing shapes of the AS curves have significant implications for macroeconomic policy. In the Classical model, government intervention is unnecessary as the economy will self-correct to full employment. However, in the Keynesian model, government intervention through fiscal and monetary policy is crucial to stimulate AD and move the economy towards full employment during recessions.