Building Blocks: Production Function Demand for Labor
In the Classical Model, the AS curve is vertical because equilibrium is determined in the labor market. In a Keynesian Model, there is no equilibrium in the labor market. The AS Curve is derived from alternative mechanisms.
Aggregate Supply, Wikipedia.
The Classical View
The Early Keynesian View
The Newer Keynesian View
See the link to the New Keynesian Economics below.
Fixed Money Wage
Recall how a profit maximizing firm determines its demand for labor:
Suppose the nominal wage rate is fixed and that the supply of labor is not a binding constraint.
Variable Money Wage
The classical labor supply assumes that workers know wages and prices. Suppose workers base their labor supply on the expected price level. If the wage rate increases, but they continue to hold the original price expectation, then we can have an increase in the equilibrium amount of labor and, hence, the equilibrium amount of output.
The variable money wage aggregate supply curve is necessarily steeper than the fixed money wage aggregate supply curve. (Proof: examine the geometry.)
As workers' price expectations adjust, the long run aggregate supply curve becomes vertical.
New Keynesian Economics