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The Phillips Curve

The simplified AD/AS model that we have used so far is fully consistent with Keynes’s original model. More recent research, though, has indicated that in the real world, an aggregate supply curve is more curved than the right angle used in this tutorial. Rather, the real-world AS curve is very flat at levels of output far below potential (“the Keynesian zone”), very steep at levels of output above potential (“the neoclassical zone”) and curved in between (“the intermediate zone”). This is illustrated in this figure. The typical aggregate supply curve leads to the concept of the Phillips curve.

Keynes, Neoclassical, and Intermediate Zones in the Aggregate Supply Curve

The graph shows three aggregate demand curves to represent different zones: the Keynesian zone, the intermediate zone, and the neoclassical zone. The Keynesian zone is farthest to the left as well as the lowest; the intermediate zone is the center of the three curves; the neoclassical is farthest to the right as well as the highest.

Near the equilibrium Ek, in the Keynesian zone at the far left of the SRAS curve, small shifts in AD, either to the right or the left, will affect the output level Yk, but will not much affect the price level. In the Keynesian zone, AD largely determines the quantity of output. Near the equilibrium En, in the neoclassical zone, at the far right of the SRAS curve, small shifts in AD, either to the right or the left, will have relatively little effect on the output level Yn, but instead will have a greater effect on the price level. In the neoclassical zone, the near-vertical SRAS curve close to the level of potential GDP (as represented by the LRAS line) largely determines the quantity of output. In the intermediate zone around equilibrium Ei, movement in AD to the right will increase both the output level and the price level, while a movement in AD to the left would decrease both the output level and the price level.

This lesson is part of:

The Keynesian Perspective

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