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Lesson 4 - Keynesian Aggregate Supply

The Keynesian view of aggregate supply differs from the monetarist view in that Keynesians believe wages and prices are sticky in the short run and do not adjust downward easily due to factors like unions and contracts. This can cause the economy to become stuck below full employment if aggregate demand falls. The monetarist view is that wages and prices fully adjust in the long run to restore full employment, but the Keynesian model suggests the economy may remain stuck for long periods due to nominal rigidities.

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32 views

Lesson 4 - Keynesian Aggregate Supply

The Keynesian view of aggregate supply differs from the monetarist view in that Keynesians believe wages and prices are sticky in the short run and do not adjust downward easily due to factors like unions and contracts. This can cause the economy to become stuck below full employment if aggregate demand falls. The monetarist view is that wages and prices fully adjust in the long run to restore full employment, but the Keynesian model suggests the economy may remain stuck for long periods due to nominal rigidities.

Uploaded by

andrewwang417
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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DO NOW:

MONETARIST LRAS

INSTRUCTIONS: Explain why in the


Monetarist/New classical model of aggregate
supply the economy will always adjust full
employment in the long-run.
3.2 Variations in economic activity—aggregate
LESSON 4: KEYNESIAN demand
AGGREGATE SUPPLY and aggregate supply

Learning Objectives
• Be able to explain the difference
between Keynesian and
Monetarist/New classical views of
aggregate supply
• Model Keynesian AS curve
• Explain phases and equilibrium
states of the Keynesian AS curve
The Lord Keynes, John Maynard Keynes,
1st Baron Keynes.
“STICKY WAGES”

INSTRUCTIONS: Summarise the key differences


between the Keynesian and Monetarist views.

• While in the monetarist view resources prices are


flexible in the long-run, changing with price
levels, Keynesian economists argue that resource
prices (particularly costs of labour) have nominal
rigidity during deflationary gaps.
• While Keynesians believe that increases in
aggregate demand will increase resource prices,
their model relies on the theory that wages are
“sticky-down”.
• Factors such as labour unionization, minimum
wage legislation, labour contracts and employer
resistance will prevent wages from falling.
RIGIDITY OF PRICE LEVELS

INSTRUCTIONS: Summarise the key differences


between the Keynesian and Monetarist views.

• Keynesian economists also argue that the sticky-


down property of wages will also translate to
general price levels.
• Prices may not easily fall because:
• Firms will not want to reduce profit (which
will occur if the price of resources do not
fall)
• Some firms may be involved in market
structure where lowering prices may lead to a
price war (i.e. oligopolies)
IMPLICATIONS OF STICKY WAGES
IN THE MONETARIST/NEW
CLASSICAL MODEL

INSTRUCTIONS: Summarise with the use of a diagram the


implications of sticky-down resources in the Monetarist/New
classical model.

• If this view of sticky wages holds then the economy may


get ‘stuck’ in the short-run for long periods of time.
• The diagram on the right reveals the implications of of
sticky-down resource prices.
• If aggregates demand decreases from to then monetarists
would expect prices levels to fall to at point b in the short-
run and eventually to at point c in the long run.
• If, as Keynesians suggests, that this fall will not occur (at
least not quickly) then the economy may be stuck either at Recall that resources prices are a determinant of
at point d if resources prices do not decrease or at if they aggregate supply, if they do not decrease then
fall slightly but not enough to return to the economy to its the SRAS curve will not shift to the right to
long-term potential output. bring the economy back to long-run
equilibrium.
KEYNESIAN AGGREGATE SUPPLY
CURVE

INSTRUCTIONS: Copy and annotate the model of


the Keynesian supply curve.

• The Keynesian AS curve therefore has the shape


seen to the right.
• The horizontal part of the curve represents the
Keynesian idea of nominal rigidity in both
resource costs and price levels.
• In the Keynesian model nominal rigidity of both
resource costs and price levels mean that the
economy cannot adjust when experiencing
Of note is the fact that Keynesian do not believe
deflationary pressure.
that price levels will never adjust, just that it can
take a very long time for this to occur. Costing
the economy through high unemployment and
low output.
PHASES OF THE
KEYNESIAN AS CURVE

INSTRUCTIONS: Read through pages 287-288 of the textbook to describe the three stages of the
Keynesian AS curve.
EQUILIBRIUM STATES

INSTRUCTIONS: Model and annotate the three states


of equilibrium in the Keynesian model of aggregate
supply.

• When the curve intersects the curve in its horizontal


section the equilibrium is given at which is less than
which represents real GDP at full employment.
• The economy is experiencing a recessionary
(deflationary) gap where unemployment is greater
than the natural rate.
• Aggregate demand is no great enough to generate
output at the potential (or higher) level.
EQUILIBRIUM STATES

INSTRUCTIONS: Model and annotate the three states


of equilibrium in the Keynesian model of aggregate
supply.

• When the curve intersects the curve at an equilibrium


level where which is more than the economy is
experiencing an inflationary gap.
• Unemployment should be below the natural rate (i.e.
greater than full employment) and price levels are
increasing.
EQUILIBRIUM STATES

INSTRUCTIONS: Model and annotate the three states


of equilibrium in the Keynesian model of aggregate
supply.

• When the curve intersects the curve at an equilibrium


level where the economy have achieved equilibrium
at the level of full employment (potential output).
RELATIONSHIP TO THE
BUSINESS CYCLE

INSTRUCTIONS: In your table groups, identify the relationship between the business cycle and the
Keynesian model for aggregate supply.
SUMMARY

INSTRUCTIONS: As a class, discuss


the questions below.

1. Describe the major differences


between Keynesian and
Monetarist/New classical views of
aggregate supply and the
implications of these differences.

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