Business Cycles - The Classical Theory

Overview

Aggregate Supply and Demand

In the classical model, supply is relatively fixed, especially in the short run. (see economic Time Frames). This is because the factors of production (think factories and total number of workers) is fixed over the short run. As such, the aggregate supply curve is vertical. That is, the supply is the same regardless of the average price level.

On the other hand, demand can fluctuate. However, it was thought that prices would adjust until the market clears. That is, changes in demand will only affect the level of prices, and not the overall production of the economy. In the chart, the x-axis is the amount of product, the y axis is the price level. The supply curve is a vertical line. The demand curve is a slanted line. Changes in the demand (represented by moving the slider) will move the demand curve, but will only move the equilibrium point to a new price level, with the same amount of product.