Introduction
There are two major school of macroeconomic thinking, the Keynesian school and the Classical school. The classical model has evolved over a long time and name of a number of renowned economists is attached to this school of thought. The Keynesian school has been built on the theories and models developed by John Maynard Keynes. In this paper we discuss the differences in these two schools of thought in terms of aggregate demand and supply and the relation between inflation and unemployment.
Aggregate Demand and Supply
The classical model is essentially a supply side model. According to the classical school of thought the gross output in an economy is determined by the production technology, labor efficiency and such other supply side factors . The classical school opines that the economy is always at the full employment level. Thus the aggregate supply is fixed at the full employment level. Thus the long run aggregate supply curve is a vertical straight line. Increase in aggregate demand, represented by a rightward shift in the AD curve will only lead to rise in the price level with no effect on the output.
The Keynesian model is a demand side model which lays importance to the impact of the changes in aggregate demand on the gross output. According to the Keynesian model an economy can operate at a level less than the full employment level of output. The aggregate supply curve in the Keynesian model is thus an upward rising curve which becomes vertical at the full employment level of output. When the economy is at an output level that is less than the full employment level an increase in aggregate demand will lead to increase in the gross output in the economy .
The difference that arises in the notion of full employment is due to the difference in opinion regarding the flexibility of wages and prices. While the classicalists believe that wages and prices are flexible and adjust freely to the change in demand and supply, Keynesian had pointed out that wages and price tend to be sticky downward. Thus in the classical model any movement away from the full employment level will lead to the adjustment of the wages and prices restoring the economy back to the full employment level.
Inflation and Unemployment
The Keynesian economists support the notion of trade off between unemployment and inflation. According to the Keynesian theory an increase in aggregate demand will lead to a rise in price that will induce more production. The higher production increases demand for labor thus reducing unemployment. Thus reduction in unemployment is accompanied by the rise in inflation. This trade off is represented by a downward sloping curve known as the Phillips Curve .
The proponents of the classical school opine that in the long run there is no trade off between inflation and unemployment. The classical school believes that in the long run the unemployment will remain at the natural rate and so the long run Phillips curve will be a vertical line at the natural rate of unemployment. According to the classical school the unemployment level can be reduced in the short run by raising aggregate demand but in the long run the wage rates will adjust to restore the unemployment to the natural rate only causing a higher rate of inflation in the process.
References
Ackley, G. (1978). Macroeconomics: Rheory and Policy. Macmillan.
Levacic, R., & Rebbman, A. (1982). Macroeconomics: An introduction to Keynesian-neoclassical Controversies. Macmillan.
Mankiw, G. (2013). Macroeconomics. Macmillan.
