classical vs. keynesian · draw an inflationary gap. 3. draw a recessionary gap. 4. define...
TRANSCRIPT
Classical vs. Keynesian
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Chapter3Unit 29Business, Computers, & Information Technology
Get your white boards!
1. Explain the results of Calvin’s proposal using AS and AD.
2. Draw an Inflationary Gap.
3. Draw a Recessionary Gap.
4. Define Stagflation.5. Name 10 College
Majors.
Review
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Adam Smith1723-1790
John Maynard Keynes1883-1946 3
Classicalvs.
Keynesian
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Debates Over Aggregate SupplyClassical Theory1. A change in AD will not change output even in the short run
because prices of resources (wages) are very flexible. 2. AS is vertical so AD can’t increase without causing inflation.
Price level
Real domestic output, GDP
AS
Qf
AD
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Debates Over Aggregate SupplyClassical Theory1. A change in AD will not change output even in the short run
because prices of resources (wages) are very flexible. 2. AS is vertical so AD can’t increase without causing inflation.
Price level
Real domestic output, GDP
AS
Qf
AD
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Recessions caused by a fall in AD are temporary.
Price level will fall and economy will fix itself.
No Government Involvement Required
AD1
Debates Over Aggregate SupplyKeynesian Theory1. A decrease in AD will lead to a persistent recession because
prices of resources (wages) are NOT flexible. 2. Increase in AD during a recession puts no pressure on prices.
Price level
Real domestic output, GDP
AS
Qf
AD
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Debates Over Aggregate SupplyKeynesian Theory1. A decrease in AD will lead to a persistent recession because
prices of resources (wages) are NOT flexible. 2. Increase in AD during a recession puts no pressure on prices.
Price level
Real domestic output, GDP
AS
Qf
AD
10Q1
• “Sticky Wages” prevents wages from
falling.• We are stuck at the new
equilibrium.• Every recent U.S. recession has followed this “GDP gap but no deflation” scenario.
AD1
Debates Over Aggregate SupplyKeynesian Theory1. A decrease in AD will lead to a persistent recession because
prices of resources (wages) are NOT flexible. 2. Increase in AD during a recession puts no pressure on prices
Price level
Real domestic output, GDP
AS
Qf
AD2
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AD1
Q1
The government should increase
spending to close the gap.
When there is high unemployment, an
increase in AD doesn’t lead to higher
prices until you get close to full
employment.
AD3
The Ratchet EffectA ratchet (socket wrench)
permits one to crank atool forward but not backward.
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Like a ratchet, prices can easily move up but not down!
Does deflation (falling prices) often occur?Not as often as inflation. Why?
Output prices rarely fall because:• Fear of price wars• Firms must pay to change prices (ex: re-pricing items
in inventory, advertising new prices to consumers…)
If output prices were to fall, the cost of resources must fall or firms would go out of business.
The cost of resources (especially labor) rarely fall because:
• Labor Contracts (Unions)• Wage decrease results in poor worker
morale and lower productivity.• Minimum wage
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Three Ranges of Aggregate Supply1. Keynesian Range- Horizontal at low output2. Intermediate Range- Upward sloping3. Classical Range- Vertical at Physical Capacity
Price level
Real domestic output, GDP
AS
Qf18
Keynesian Range
IntermediateRange
ClassicalRange