Chapters 8.4 and 8.5

(Macroeconomics controversies: the keynesian perspective & Some final observations)

Jhon Maynard's effect in American economy

keynes-1.jpg The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”| John Maynard Keynes

Jhon Maynard Keynes, is still one of the most famous economist of the 20th century , he questioned the classical economists view of the economic system as a harmonious system that automatically tends towards full employment and istead showed that is is possible for economies to remain in a position of short-run equilibrium for long period of time.
The long-run aggregate supply curve in the neoclassical perspective depends on the principle that all resource price and product prices are fully flexible and respond to the forces of suplly and demand. But Keynesian economist argue that there is an asymmetry between wage movements in the upward and downward directions becuase both wages and price are unlikely to fall even if the economy is in a recessionary gap, and even if the recessionary gap persist iver long periodd of time.

If wages and prices do not fall easily even over long periods of time, this in effect means that the economy may get stuck in the short run, and cannot move into the long run. This happens when the economy is at a point (a) producing potential output Yp. There occurs a decrease in aggregate demand. The fall in the price level and in the wages caused the recessionary gap to dissapear. If the price level cannot fall the economy will be unable to eliminate te recessionary gap, which will be stuck in the short-run and will be unable to mve into the long-run.


The Keynesian AS curveThe shape of the Keynesian aggregate supply curveThe aggregate supply curve has three segments:

Segment 1
  • Real GDP is low, and price level remains constant as real GDP increases.
  • In this range of real GDP there is a lot of unemployment of resources.( which means that if the firm want to increase their output
they can easily do so by employing the unemployed labour.)
Segment 2
  • As the real GDP continue to increase, the AS curve begins to rise, so that real GDP increase are accompanied by increase in price level.
  • Firms are forced to use less and less efficient resource, (which means that even thought wage are held constant, the cost of production p/u
of output increases.)
  • The only way firms will be induced to increase their output is if they can sell it at a higher prices.
Segment 3
  • The AS curve become vertical indicating that real GDP reaches a level beyond which it cannot increase any more.
  • NOTE: Any effort on the part of firms to continue increase their output willonly give rise to greater increase in the price level

Keynesian Aggregate Supply Curve

The Three short-run equilibrium states of the economy in the keynesian perspective:
Recessionary Gap
Inflationary Gap
Full employment equilibrium the AD intersecting the keynesian
AS curve in its horizontal
2. It can be related to the business cycle when there correspond to a point where there is a
recessionary gap.
1.Is experiencing an inflacionary gap. There is strong aggregate
demand, unemployment has fallen below its natural rate,
and the economy approaches its maximun capacity.
2.It can be related to the business cycle when there is an inflationary gap
1. Show the case wherethe economy has achieved full employment equilibrium.
2. It can be related to the business cycle when the economy's actual output s equal to its
potential output, or full employment.
graph_1.pnggraph_2.pnggraph_3.png KADAS.jpg In the Keynesian perspective, an economy can remain for a long period of time in an equilibrium position where there is less full employment, which is caused by insufficient aggregate demand.

Another important principle is that increasing in aggregate demand need not always cause increases in the price level. In the long run incease in agrgregate demand give rise only to increase in the price level, while leaving real GDP unaffected. In Keynesian perspective by contrast, when the economy is in horizontal range , increases in aggregate demand lead to increase in real GDP without affecting