Long-run AS: Keynesian and classical views

The classical (free market) LRAS

Classical economists argue that in the long run wages and prices are fully flexible, so the economy returns to full employment. LRAS is vertical at the full-capacity level of output (Yfe).

In words: a vertical line at Yfe. If AD shifts right, the price level rises but long-run output does not change. Only supply-side improvements that shift LRAS right raise output in the long run.

The Keynesian AS curve

Keynesians argue that the economy can stay below full employment for a long time because wages are sticky downwards and AD may be too low.

In words, the Keynesian AS curve has three parts: a horizontal section at low output (lots of spare capacity, so more output with no rise in prices); a curved, upward-sloping section as bottlenecks appear; and a vertical section at full capacity (Yfe).

Implication: when output is on the horizontal section, a rise in AD raises output and jobs without inflation.

Factors shifting LRAS

• Technology: new methods raise output from the same inputs.
• Productivity: output per worker or per hour.
• Education and skills: human capital.
• Government regulations and tax: excessive red tape raises costs; lower taxes on income and profits can raise incentives to work and invest.
• Demography and net migration: a growing working-age population raises the labour force.
• Competition policy: more competition pushes firms to cut costs and innovate.

An increase in any of these shifts LRAS (and the vertical part of the Keynesian curve) to the right.

Worked example

An economy is in deep recession with high unemployment. Compare the effect of a rise in AD under Keynesian and classical views.

1. Keynesian: output is on the horizontal section, so AD shifting right raises real output and employment with little or no rise in the price level.
2. Classical: LRAS is vertical, so in the long run wages and prices adjust and only the price level rises.

Answer: Keynesians expect real gains; classical economists expect only inflation in the long run.

Check yourself

1. On a classical LRAS diagram, a rightward shift of AD in the long run causes
   • higher real output with no change in the price level
   • higher output and a higher price level
   • a higher price level with no change in real output
   • lower output
   Show answer

   a higher price level with no change in real output. LRAS is vertical, so only the price level changes.

2. On the horizontal section of a Keynesian AS curve, a rise in AD causes
   • a rise in real output with no rise in the price level
   • a rise in the price level only
   • a fall in output
   • a leftward shift of AS
   Show answer

   a rise in real output with no rise in the price level. There is lots of spare capacity, so output rises without inflation.

3. Which would shift LRAS to the right?
   • A rise in consumer confidence
   • A rise in VAT
   • Improved education and training raising labour productivity
   • A cut in interest rates that raises consumption
   Show answer

   Improved education and training raising labour productivity. Higher productivity increases productive capacity.

4. A sustained rise in net inward migration of working-age people is most likely to
   • shift LRAS to the left
   • shift LRAS to the right
   • shift SRAS to the left
   • make LRAS horizontal
   Show answer

   shift LRAS to the right. The labour force grows, raising potential output.

5. Why is the classical LRAS curve vertical?
   • Firms never change output
   • The government fixes output
   • Demand never changes
   • In the long run wages and prices are flexible, so output returns to its full-capacity level
   Show answer

   In the long run wages and prices are flexible, so output returns to its full-capacity level. Flexible wages and prices clear markets at full employment.

6. On the upward-sloping middle section of the Keynesian AS curve, why do prices start to rise?
   • Unemployment is very high everywhere
   • Bottlenecks and shortages of some resources appear
   • Firms have lots of spare capacity
   • The money supply is falling
   Show answer

   Bottlenecks and shortages of some resources appear. Some industries and skills reach capacity before others.

7. Explain how stronger competition policy could shift LRAS to the right.
   Show answer

   More competition forces firms to cut costs, become more efficient and innovate, raising productivity and the economy's productive capacity.. Competition, efficiency and innovation, higher productivity, more capacity.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2 (June 2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.