Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

FIGURE 9.5: CLASSICAL AGGREGATE SUPPLY CURVE 
In upper panel of the diagram, the labour market is at 
equilibrium at full employment which is shown as N
F
. The 
corresponding output is shown in lower panel of the diagram as 
OY*. This output is termed as potential output or full employment 
output. 
The potential output is unaffected by changes in prices 
because there is full flexibility of money wage and prices which 
ensures the current real wage. Therefore, the aggregate supply is 
vertical given as Y*S. 
The vertical curve in the Classical model is based on the 
following assumptions. 
1. Prices, money wage and real wage are fully flexible. So 
that labour market clears instantaneously. 
0
*
Y
S
Output
Pr iceLevel
0
Labour
RealWage
s
L
d
L
0
w
1
w
K
F
E
F
N

---

2. There is no money illusion. Money illusion exists when 
people and firms respond to nominal values and not to real 
values. 
9.3.1 Shift of the Aggregate Supply Curve: 
 
The shift in the aggregate supply curve takes place on 
account of factor on demand side and supply side of labour market. 
If the given stock of capital goods and technology allowed to 
change marginal productivity of labour will shift to right and hence 
labour demand will also shift to the right. This will lead to an 
increase in employment and shift of aggregate supply curve to the 
right. This is shown in the following diagram.
FIGURE 9.6: SHIFT IN THE AGGREGATE SUPPLY CURVE 
S
1