Unit 3: Aggregate Demand and Supply and Fiscal Policy Copyright ACDC Leadership 2015 1 Adam Smith 1723-1790 Copyright ACDC Leadership 2015 Classical vs. Keynesian John Maynard Keynes 1883-1946 2 Copyright ACDC Leadership 2015 3 Keynes vs. Hayek Rap Battle Copyright ACDC Leadership 2015 4 Debates Over Aggregate Supply Classical Theory 1. 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 AS AD Copyright ACDC Leadership 2015 Qf Real domestic output, GDP 5 Debates Over Aggregate Supply Classical Theory 1. 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 AS Recessions caused by a fall in AD are temporary. Price level will fall and economy will fix itself. No Government Involvement Required AD AD1 Copyright ACDC Leadership 2015 Qf Real domestic output, GDP 6 “The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again” John Maynard Keynes Translation: In times of need, economists should do more than say that the economy will fix itself. They should suggest policies that can help the economy, like deficit spending. Do you agree or disagree? 7 Debates Over Aggregate Supply Keynesian Theory 1. 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 doesn’t cause inflation Price level AS AD Copyright ACDC Leadership 2015 Qf Real domestic output, GDP 8 Debates Over Aggregate Supply Keynesian Theory 1. 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 AS Price level “Sticky Wages” prevents wages from falling. The government should deficit spend to close the gap AD1 Copyright ACDC Leadership 2015 AD Q1 Qf Real domestic output, GDP 9 Debates Over Aggregate Supply Keynesian Theory 1. 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 AS Price level AD1 Copyright ACDC Leadership 2015 When there is high unemployment, an increase in AD doesn’t lead to higher prices until you get close to full employment AD3 AD2 Q1 Qf Real domestic output, GDP 10 Three Ranges of Aggregate Supply 1. Keynesian Range- Horizontal at low output 2. Intermediate Range- Upward sloping 3. Classical Range- Vertical at Physical Capacity AS Price level Classical Range Keynesian Range Intermediate Range Qf Real domestic output, GDP 11 2006B Practice FRQ Copyright ACDC Leadership 2015 12 2006B Practice FRQ Copyright ACDC Leadership 2015 13
