Keyenesian (Horizontal) Aggregate Supply Curve

Classical economists assumed that all

resources present in the economy
were being used at capacity. However,
this
theory
was
a
complete
contradiction to the actual economy
during the world depression that
started
in
the
1930s
where
unemployment was rampant and
factories were idle.
John Maynard Keynes argued that
prices and wages were sticky, in
particular
they
were
inflexible
downward due to the existence of
unions
and
contracts
between
employers and employees.
He argued that in a world of excess
capacity, an increase in aggregate
demand will not impact prices (as the classical economists thought) but will instead impact
real GDP.
The assumptions of the Keynesian model are the same as the classical model except for two
important differences: prices and wages are sticky, and excess capacity exists in the
economy.

Within the Keynesian framework, the aggregate supply (AS) curve is drawn
horizontally. This is done because prices are sticky in the short run, represented by the flat
line (prices dont change). Because this only occurs in the very short run, we label this the
short run aggregate supply curve (SRAS).
Three possible justifications for increases in short run GDP:
1) Shifts from Uncounted production toCounted Production. Eg. Janitors now make stuff
(counted) instead of cleaning stuff (uncounted). Remember that GDP counts the final value
of a good or service produced, so if a janitor cleans a machine, the value of the service is
included in the final value of the item made by that machine. By allowing the janitor to use
the machine to make more stuff, real GDP will rise.
2) Existing capital is used more intensively; a factory can run 24 hours a day instead of just
8 hours a day. Other forms of capital can also be used more intensively so that real GDP will
rise.
3) If prices are higher, the unemployed are more likely to accept jobs, and homemakers,
younger and older people are more likely to enter the workforce. This results in an increase
in the amount of labor in the economy which increases production and thus real GDP.

Finally, new Keynesians realized that prices and wages were not perfectly sticky, even in the
short run. Because of this they developed a new SRAS curve which was upward

sloping. This allowed for some price and

wage stickiness, but also allowed for
some flexibility. This upward sloping
SRAS supply curve has become the
standard SRAS curve used in economic
analysis. You may also see charts that
show two SRAS curves, one horizontal,
and one upward sloping. Generally the
horizontal curve shows the very short
run, and the upward sloping shows the
short to medium run aggregate supply
curve. In the long run, we end up back
with the classical model, so the three
different aggregate supply curves show
us how prices and real GDP will change
over short, medium, and long time
frames.