Download Macro_3.4-_Classical_vs._Keynesian

Unit 3-4:
Aggregate Demand and
Supply and Fiscal Policy
1
Debates Over Aggregate Supply
Classical Theory
1. A change in AD will not change output even in the short run
because prices of resources (wages) are very flexible.
2. AS is vertical so AD can’t increase without causing inflation.
Price
level
AS
AD
Qf
Real domestic output, GDP
2
Debates Over Aggregate Supply
Classical Theory
1. A change in AD will not change output even in the short run
because prices of resources (wages) are very flexible.
2. AS is vertical so AD can’t increase without causing inflation.
Price
level
AS
Recessions caused by a fall
in AD are temporary.
Price level will fall and
economy will fix itself.
No Government Involvement
Required
AD
AD1
Qf
Real domestic output, GDP
3
“The long run is a misleading guide to current
affairs. In the long run we are all dead.
Economists set themselves too easy, too useless
a task if in tempestuous seasons they can only
tell us that when the storm is past the ocean is
flat again”
John Maynard Keynes
Translation:
In times of need, economists
should do more than say that
the economy will fix itself.
They should suggest policies
that can help the economy, like
deficit spending.
Do you agree or disagree? 4
Debates Over Aggregate Supply
Keynesian Theory
1. A decrease in AD will lead to a persistent recession because
prices of resources (wages) are NOT flexible.
2. Increase in AD during a recession doesn’t cause inflation
Price
level
AS
AD
Qf
Real domestic output, GDP
5
Debates Over Aggregate Supply
Keynesian Theory
1. A decrease in AD will lead to a persistent recession because
prices of resources (wages) are NOT flexible.
2. Increase in AD during a recession puts no pressure on prices
AS
Price
level
“Sticky Wages” prevents
wages from falling.
The government should
deficit spend to close the
gap
AD1
AD
Q1
Qf
Real domestic output, GDP
6
Debates Over Aggregate Supply
Keynesian Theory
1. A decrease in AD will lead to a persistent recession because
prices of resources (wages) are NOT flexible.
2. Increase in AD during a recession puts no pressure on prices
AS
Price
level
AD1
When there is high
unemployment, an
increase in AD doesn’t
lead to higher prices
until you get close to full
employment
AD3
AD2
Q1
Qf
Real domestic output, GDP
7