Classical v Keynesian AS curve

Page 1

Classical AS curve

LRAS shows productive capacity of an economy using its factors of production.

Factos influencing LRAS:

technological advances

changes in education and skills

changes in relative productivity

changes in government regulations

demographic changes and migrations

competition policy

The classical view of LRAS suggests that the economy will always produce the maximum that its factor resources will allow.

Classical economists believe that markets will always function efficiently over the long run and so an economy will produce on the outer boundary of its production possibility curve thus the LRAS curve is vertical marking a maximum limit of production.

Page 2

Keynesian AS curve

John Maynard Keynes however believed that an economy could be in equilibrium below full employment.

Through his study of the Great Depression he concluded that the LRAS curve was upward sloping and did have a vertical section (like the classical LRAS curve) but at times an economy could settle at a level of output below full employment.

Inflationary gap: actual output > potential output

A = unused capacity

Firms can increase output without increasing costs

B = Limited spare capacity

As the economy nears full employment firms find it more difficult to attract scarce resources so prices begin to rise

C = Full capacity

There os full employment and all resources are used

As per the classical LRAS curve any change in either the quality or quantity of factors of production will shift LRAS.

Page 3