Classical and Keynesian Perspectives on Aggregate Supply

Most neoclassical economists utilize aggregate supply as their economic paradigm. Economists rarely used demand and supply models in the 18th and 19th centuries. Classical economists believe that markets are reasonably efficient and competitive, implying that they can respond instantly to a shortage or surplus. As a result, such adjustments suggest that wages and prices will continue to fluctuate quickly and freely in order to support full employment. This means that a completely competitive market frequently maintains its equilibrium (Stonecash, 2011). The aggregate supply curve is usually a vertical line attained at full employment and denotes the potential GDP (Coppock & Mateer, 2014). Classical economists believe the only way positive economic growth can be attained is through a gradual increase of the potential GDP. Therefore, this implies that a rise in aggregate demand can only result in inflation.

Keynesian theorists describe aggregate supply as a horizontal line attained at the current price levels. Keynesian economists espouse that the competitive nature of the market is significantly impaired by the actions of unions and large corporations. In this regard, wages tend to remain relatively sticky. This implies that changes in aggregate demand have an insignificant influence on the price levels (Sayre & Morris, 2014). For instance, during recessionary periods, the wage levels rarely drop, and hence the aggregate supply will also remain constant. However, fluctuations in aggregate demand can only influence the current price levels when economies are operating at their optimal full employment levels. Nonetheless, in the absence of government interventions, there is no assurance that economies can ever attain full employment (Mankiw, 2014).

Classical and Keynesian Perspectives on Fiscal Policy

The notion that contractionary and expansionary fiscal policies can be employed to influence macroeconomic outcomes is closely associated with the Keynesian school of thought. Keynesian economists espouse that governments are required to employ fiscal policy measures, particularly during periods of recessions (Sayre & Morris, 2014). The classical school of economic thought holds that contractionary and expansionary fiscal policies are not required since markets are driven by internal mechanisms. For instance, the flexible fluctuation of prices and wages serves to ensure that markets always oscillate at their natural levels of GDP. Similarly, classical economists espouse that governments are required to run balanced budgets annually (Coppock & Mateer, 2014).

References

Coppock, L., & Mateer, G. D. (2014). Principles of macroeconomics. New York: W. W. Norton.

Mankiw, N. G. (2014). Principles of macroeconomics. New York: Cengage Learning.

Sayre, J. E., & Morris, A. J. (2014). Principles of macroeconomics. Toronto: McGraw-Hill.

Stonecash, R. E. (2011). Principles of macroeconomics. South Melbourne, Victoria: Cengage Learning.