Classical supply curve

Classical economist believe that there are no short-run rigidities and that only real variables determine output. This means that the classical aggregate supply curve is exactly the same as the long run aggregate supply curve - upward sloping.

classical-supply-curve

The diagram above portrays the short and long run equilibrium. The point where aggregate demand intersects with the vertical line is what determines the level of output. In a classical economics world, if there is a shock to aggregate demand, the price level adjusts to return the economy to its natural level of output and return employment to its natural level of employment.

This view of the world has consequences. It means that governments should not try to stimulate the economy to move the economy out of recession. Classical economist believe recessions are caused by changes to the natural level of output and that government stimulation will just cause the price level to increase. This leaves no scope for fiscal or monetary policy.

Suppose that the government thought that the economy was under-performing, so they increased government spending, leaving all other variables constant.

classical-supply-curve_demand_shock

This would cause the demand curve to shift to the right. However, since the supply curve is a vertical line this would only cause an increase in the price level and output would remain the same. Essentially, we would get no increase in employment but we would see higher inflation.

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