Keynesian AD/AS

• Classical model


  Model of aggregate demand and aggregate supply
• Keynesian model


  Model of aggregate demand and aggregate supply
• Keynesian model fundamentally disagreed with the classical model and its assumptions

  Especially the short run long run difference which Keynes said is complete rubbish and doesn't exist in the real economy
• Wages


  Keynes said the assumption of wages being variable in the long term is a crazy assumption
• Keynesian aggregate supply

  • Not different in the short run and long run
  • Determined by the level of spare capacity in the economy
  • There is a Full Employment level of output which represents the maximum use of all factors of production in the economy at sustainable levels
• Keynesian aggregate supply curve

  Can be horizontal as well as vertical
• Horizontal Keynesian aggregate supply curve


  Represents a point in time where there is so much spare capacity in a recession, where output can increase without any inflationary pressure
• Keynesian disagreements with the classical model

  • Notion of short run and long run
  • Wages changing in the long run and becoming variable
  • Belief that the economy will self-heal
• Keynesian view on wages

  Wages are sticky going downwards, workers are very resistant to pay cuts
• Waiting for wages to adjust downwards in the long run

  We'll all be dead by the time that happens
• Deflationary or recessionary gap


  In the Keynesian model, this could well be a long run equilibrium because wages don't adjust
• Keynesian solution

  1. Active demand side management in the economy

  2. Policies to increase aggregate demand to move the economy closer to full employment

  3. Use active fiscal policy - increase government spending, reduce taxes
• Politicians liked the Keynesian theory because it promoted a greater role for government, and meant they could increase AD without much inflationary pressure
• The Keynesian theory became quite successful and popular during the Great Depression for these reasons