Monetarist v. Keynesian AS Curve
There are opposing theories amongst the Monetarists and the Keynesians as to how the LRAS curve should look. Monetarists believe that in the short run markets may not be in equilibrium but they would always clear (demand equals supply) in the long run. They also believe that if the economy is working efficiently and all resources are utilised that the economy must be on a point of the PPF.
Monetarists believe that the LRAS is completely vertical as there is no spare capacity in an economy. The maximum output is already being produced; this means that any shifts in the AD curve will only cause increases in the price level (inflation) and will have no effect on output levels.
During the Great Depression most economics were monetarists (classical) and believed that the economy would clear; they believed that excess supply was caused by high wages rates and as unemployment rose the wage rates would fall and an equilibrium would be found. This didn’t happen and John Maynard Keynes proposed that an economy can reach an equilibrium that was not its full employment equilibrium (going against monetarist beliefs). He believed this was caused by sticky wages (they wouldn’t fall any further) and hence there was still excess supply.
The Keynesian model is the same as the 3-step LRAS curve shown in the section above.
The Keynesian underemployment equilibrium is a macroeconomic equilibrium where full employment isn’t guaranteed.
Keynes believed that to solve this issue of underemployment that rather than let wages fall (like the monetarist view of how the markets should clear) and cause a rightward shift of the SRAS curve (which would lead to more AD and less inflation) there should be an increase in AD to cause a rightward shift. Obviously in a recession this is unlikely to occur through increased consumption or business investment, Keynes believed that governments should intervene to increase the AD. He believed this could be done through infrastructure which would not only create jobs but would lead to better transport and networks.
Page last updated on 20/10/13
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