Alternative Views of Aggregate Supply

You are expected to explain/analyze (AO2) and draw (AO4) LRAS, Keynesian AS, inflationary and recessionary gaps, and shifts in both AS models, and evaluate/examine (AO3) assumptions and implications of both views (SL+HL)

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Alternative Views of AS

Macroeconomic Equilibrium

Long-Run Aggregate Supply (LRAS) Curve (AO2, AO4)

This is the maximum level of real GDP that the economy is currently hypothetically able to achieve, with full employment in all sectors. It is impossible to produce more than this level given the current technology and productivity in the economy.
The curve is vertical as it is independent of price, and will only shift from a few factors explained further down.
This curve is only used by neoclassicalists. Keynesians use another curve, as shown and explained below:

Keynesian Aggregate Supply Curve (AO2, AO4)

The Keynesian AS curve is an alternative to SRAS+LRAS.

In contrast to the neoclassical setup with 2 AS curves (SRAS and LRAS), Keynesians believe in 1 unified Aggregate Supply (Keynes himself said that "in the long run, we are all dead")
At low economic output, there is plenty of spare capacity in the economy, and extra output can be ensured without any strain on price.
Once this spare capacity diminishes, there is pressure on scarce resources, increasing the general price level.
At some point, everything will be fully employed, and it will be impossible to produce more output regardless of price level, similar to the LRAS.

Inflationary and Deflationary Gaps (AO2, AO4)

This applies to the neoclassical model only.

Inflationary gaps occur when the economy has a higher output than its potential, in other words, employment is beyond full. This is not ideal because it will lead to higher prices. AD/SRAS equilibrium is beyond LRAS.
Deflationary gaps occur when the economy has a lower output than its potential, in other words, it has unemployment of at least one factor of production. This is not ideal because it leads to inefficiencies. AD/SRAS equilibrium is behind LRAS.

Shifts in LRAS and Keynesian AS (AO2, AO4)

Shifts in these two curves may occur due to any of the following:

Changes in quantity and/or quality of factors of production
Improvements in technology
Increases in efficiency
Changes in institutions

Assumptions/Implications of the Neoclassical and Keynesian Models (AO3)

Neoclassical:

Believe markets are self-regulating and government intervention is not necessary.
Prefer policies that free up markets such as market-based supply-side policy.
This school of thought originated in post-WWI Austria where inflation was rampant; As a result, inflation is considered very important.

Keynesian:

Keynesian economists believe government intervention is necessary to ensure full employment and economic growth.
Keynesians prefer policies that regulate/intervene in markets such as fiscal policy.
This school of thought originated in the Great Depression in the US where unemployment was rampant; As a result, unemployment, human well-being, and economic growth are considered much more important than inflation.

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