Unit 9.4 9.5 9.6

Question 1

Describe aggregate supply in the Keynesian model

Answer 1

An aggregate supply curve that shows relashionship between real GDP and price level on the assumption that prices and wages are inflexible downward.Changes in the price level and real gdp depend on the aggregate demand and where the economy is producing relative to full capacity.

Question 2

Explain why curve can be horizontal in keynsian model

Answer 2

Keynes believes during periods of spare capacity (in a recession for example) an economy can be stuck way less then full employment the economy will not self heal to the full employment , when output increases there isn’t much pressure put on resources, on the factors of production, therefore the prices of those resources does not have to rise, therefore there might not be any inflation as output increases (which is why curve is horizontal)

Question 3

What does keynes propose to do to increase AD?

Answer 3

(demand side policies) Active fiscal policy:
Increase government spending and reduction in income tax

Keynes believed that waiting for wages to adjust downward in the long run would lead to prolonged high unemployment and social issues. Instead, he advocated for active demand-side management of the economy through policies that increase aggregate demand and move the economy closer to full employment. He suggested using fiscal policy, such as increasing government spending and reducing taxes, even if it meant running a budget deficit. He argued that in times of economic expansion, the increased tax revenue and reduced government spending would help offset the deficit.

To address the inflationary gap, Keynesian economists often advocate for fiscal policy measures, such as reducing government spending or increasing taxes, to dampen aggregate demand and bring it back in line with the economy’s capacity. The aim is to reduce the upward pressure on prices and restore macroeconomic stability.

Question 4

To decrease AD what does keynes propose?

Answer 4

Contractionary monetary policies:

Increasing interest rate: Increases savings and reduces borrowing, hence reduces consumption spending.

Question 5

What are the two differences between neo-classical and Keynesian models?

Answer 5

1. Automatic self-correction vs persistence of deflationary gaps over time.
2. Increases in AD causes vs doesn’t have to cause increase in price level.

Question 6

What does Keynesian economics reject (and therefore what analysis is it)?

Answer 6

1. The idea that prices and wages become flexible.
2. Making it a short-term analysis.

Question 7

What are the implications of the first difference for policy for NC and K model

Answer 7

1. NC: governments should work to make markets as free as possible.
2. K: governments should implement measures against deflationary gap.

Question 8

What are the implications of the second difference for policy? for NC and K model

Answer 8

1. NC: supply side policy for long term growth (LRAS shift right).
2. K: demand-side policy.