LS6 Classical And Keynesian Flashcards
What do both Keynesian and classical economists agree about the short run, aggregate demand curve
And about the diagram in general
- but aggregate demand curve is downward sloping
- The aggregate supply curve is upward sloping
- Equilibrium level of output in the short run occurs at the intersection of AD and AS curves
What is aggregate demand made up of?
- Consumption
- Investment
- Government spending
- Exports minus imports
What are some examples of what could cause an increase in aggregate demand?
- a fall in interest rates will raise consumption and investment
- a fall in the exchange rate, will boost exports and reduce imports
- Lowering income tax will raise consumption (This is because households have higher disposable income)
What will fall in aggregate demand in the short run look like?
What would a rise look like?
A shift left causing an decrease in real output and price level in the short run
A rise would look like a shift right, causing an increase in real output and price level
What are some examples of what could cause a fall in short run aggregate supply?
- wages of workers, rising
- Raw materials prices going up
- Taxes on goods and services
- generally caused by a rise in the cost of production
What does a fall/rise in the short run aggregate supply curve look like?
- A fall would cause a shift upwards and to the left meaning price increases and output decreases
- Arise would cause a shift downwards and to the right meaning price decreases and output increases
What do classical economists argue about long run aggregate supply curve
Discuss LRAS in given context
That it is vertical
Long run equilibrium occurs when the long run aggregate supply curve intersects, the aggregate demand supply curve . The long run aggregate supply curve shows the supply curve for the economy at full employment. Classical economists think there can be no unemployment in the long run.
What do Keynesian economists argue about long run aggregate supply curve
Discuss LRAS in given context
- The LRAS curve is not that cool, but rather horizontal curving to vertical
- The economy can be in equilibrium at less than full employment
- The key point of disagreement between classical and Keynesian economist is the extent to which workers accept real wage cuts (reaction to unemployment)
Discuss the difference between a classical and Keynesian viewpoint of unemployment.
- classical economists: a rise in unemployment will lead to cuts in real wages. This will increase the quantity of labour demanded and reduce the quantity supplied, which will return the economy to full employment quickly and automatically
- Keynesian economists: money wages are sticky downwards (it won’t move and resists change in a downwards direction). Workers will refuse to take a wage cuts, and will resist fiercely. The labour market will, therefore not clear, except over a long period of time.
If there is a rise in aggregate demand, what does this look like in:
- Classic model
-Keynesian model
- classical model: this will lead to a rise in price level, but no change in real output. No amount of extra demand will raise long run equilibrium output because economy is a maximum productive capacity.
- Keynesian model: an increase in aggregate demand would be purely inflationary. If the economy is already at full employment, this is in agreement with classical economist. If in deep depression, the reaction of the economy to an increase in A.D. would be an increase in equilibrium output without a rise in price level. If the economy is a little below for employment (cover), then an increase in A.D. will increase equilibrium output and price.
Look at brainscape is for classical model in short and long run, diagram for rise in aggregate demand
:)
Explain why aggregate demand increases price but not output in the classical model
(detailed)
- If there is a rise in aggregate demand, the aggregate demand curve shifts up in the short run
- this will result in a movement up the SRAS curve, but the economy will be in the long run disequilibrium because it is over maximum capacity,
- The economy is operating at over full employment so firms will find it difficult to recruit labour, buy raw materials, or find new offices. Therefore they will increase wages and other costs.
- The curve assumes wage rates and costs remain constant so the rising wage rates will shift short run aggregate supply upwards
- This causes output to full and prices to keep rising
What does a rise in long run aggregate supply mean?
The economy’s potential output has increased
What will an increase in the long run aggregate supply lead to in the classical model?
It will lead to both higher output and lower prices
- When aggregate demand has increased prices rise with no increase in output, which is why classical economists are very in favour of supply-side policies
What will an increase in long run aggregate supply lead to according to the Keynesian model
An increase in output and a reduction in prices, if the economy is up full employment
If it’s at slightly less than full employment output will still increase and prices will reduce, and it will still be beneficial to the economy
But when the economy is in a deep depression, an increase in aggregate demand will have no effect on equilibrium output. Only an increase in aggregate demand can move the economy out of depression.
