Keynesian curve Flashcards
What is the Keynesian theory?
Theory that argues that demand creates its own supply. Changes in AD causes changes in real GDP and employment. The theory suggests that the solution to a recession is expansionary fiscal policy that shifts the AD curve to the right.
Expansionary fiscal policy
This involves the government aiming to increase aggregate demand by deliberately increasing government spending and/or lowering direct and indirect taxes which is financed by an increase in the size of the budget deficit.
3 parts of the Keynesian curve
Keynesian, Intermediate and Neoclassical zone
Keynesian Zone
The portion of the SRAS curve on the left that is relatively horizontal and flat. The economy is not at full capacity. GDP is far below GDP potential and cyclical unemployment is high.
Shifts in the Keynesian zone
If AD shifts left or right in this zone, it will determine the resulting level of output and thus employment. There is no worry of inflationary pressures in this zone as P doesn’t vary much in this zone.
Neoclassical zone
The portion on the SRAS curve on the right that is sloping upwards. At this point, we are approaching full capacity and cyclical unemployment is low although structural unemployment is an issue. The only way to increase the size of real GDP is for AS to shift right.
Shifts in the Neoclassical zone
Shifts of AD to the right or left have little affect on the level of output or unemployment. However a shift in AD create some inflationary pressure.
Intermediate zone
The portion of the SRAS curve on the far right that is close to vertical. At this point, we are either very close to or at full capacity. Full unemployment and all raw materials are being used
Shifts in the intermediate zone
A shift right in AD will move output closer to potential GDP and reduce unemployment, but increase price levels and inflationary pressures. A shift left in AD would do the opposite.
