Keynesian Aggregate Supply/Aggregate Demand (AS/AD)

hi everyone let's now compare the

clasica model to the Keynesian model of

aggregate demand and aggregate supply

KES fundamentally disagreed with the

classical model and its assumptions

especially he said this whole short run

long run difference is complete rubbish

doesn't exist in the real economy he

talked about wages being variable in the

long term as a crazy assumption and

therefore he came up with a very

different idea of aggregate supply and a

very different idea of macroeconomic

management in the

economy uh first of all he talked about

aggregate supply not being different in

the short RM and the long RM he just

said aggregate supply is aggregate

supply full stop and it looks like this

it's determined by the level of spare

capacity in the economy so he did agree

that there comes a point in the

economy

where production cannot increase

uh sustainably and that is the Full

Employment level of output which

represents the same idea in the

classical model which is maximum use of

all factors of production in the economy

at sustainable levels and he agrees

there comes a point at one output level

where the economy can't move beyond that

um sustainably and that's the Full

Employment level of output so there is a

point where the long run aggregate

supply code becomes vertical but he

argues that it's not always vertical no

way there are times where it can be be

horizontal as well which represents a

point in time where there is so much

spare capacity in a recession for

example in which

case um an economy can be stuck uh way

way less than full employment uh and

therefore need some sort of

macromanagement need some sort of

policies to actually get back to full

employment the economy will not self

heal itself back to

YF he also argues that when there is

lots of spare capacity uh output can

increase without any inflationary

pressure at all which is why this curve

can be horizontal and that's simply

because during periods of lots of spare

capacity when output increases there

isn't much pressure put on resources on

factors of production therefore the

price of those resources doesn't have to

rise in which case there might not be

any inflation as output increases at all

which is why the curve can be horizontal

as well so his fundamental disagreements

come with this notion of short run and

long run the fact that W wages change in

the long run and become variable and the

classical economists believe that when

that happens the economy will self-heal

Kan says no that's a terrible assumption

to make because workers do not like to

especially reduce their wages in a

period of recession and he said in

recession this is where my major problem

exists way workers don't revise down

their weight expectations who likes to

take a payer nobody in his terminology

wages are sticky going downwards workers

are very resistant to a pay cut in which

case if you wait for the long run you

wait for wages to reduce for the economy

to self-heal well then as you keep

waiting for that long run we'll all be

dead using Kane's terminology right

there that's exactly what you said he

said well you're going to keep waiting

waiting waiting waiting and the problem

is as you're waiting we're going to be

suffering as an economy with very high

levels of unemployment and all the

social unrest and problems that that can

bring in which case you wait for wages

to adjust downwards we'll all be dead by

the time that happens and he said that

during the Great Depression in the late

1920s and early 1930s when politicians

were very much following a classical

school of thought waiting for wages to

revise downwards and for the economy to

self heal there was no evidence of that

taking place uh and this was uh this is

what fueled kan's in argument this is

what fueled canes to come up with his

general theory and to say no let me

revise what aggregate supply looks like

and therefore let me come up with a new

Theory and basically he said in periods

of

recession so over

here where output in the economy is way

less than the Full Employment level of

output known as a deflationary or

recessionary Gap in the kynan model so

deflationary or a recessionary

gap K's argued that that could well be a

long run equilibrium that doesn't just

have to be be a shortterm equilibrium

like the classical Economist would argue

that could well be a longterm

equilibrium why because wages don't

adjust he said wages are sticky

downwards we're not going to see revised

down revision downwards of wages at all

we could be stuck there for the long

term in which case the economy is going

to suffer from mass unemployment it's

going to suffer from unrest and the

social issues that that can bring

therefore he said what we need is not to

wait right waiting would just lead to

more problems he says we need active

demand side management in the economy

policies that will increase aggregate

demand that will move the economy closer

to our full employment levels of output

and he said in a recession the easiest

way to do that the most direct way to do

that is to use active fiscal policy an

increase in government spending and a

reduction in income tax or corporation

tax to increase aggregate demand to take

us closer to YF Bas to do something like

that and he said if that means borrowing

money the government has to borrow then

so be it because in times of boom that

money will come back to the government

with higher tax revenue collection and

lower government spending necessary so

he says yeah fair enough take uh a

budget deficit in that year accept

borrowing accept the PSNC whatever do so

um to increase aggregate demand that's

un necessary otherwise we'll be stuck

here and the economy will suffer now

it's no surprise that politicians like

this idea like this Theory very much

because it promoted a greater role for

government it meant that government

could increase in size um it also meant

that if it worked politicians can you

know very much you know Target the fact

that they got involved and used that as

a great way to actually uh gain

popularity so politicians liked it for

that reason too but also it was a a nice

theory for politicians to follow because

it meant that maybe they could increase

ad without much inflationary pressure

According to kan's which again meant

that they can achieve their

macroeconomic objectives without the

conflict of inflation that normally

would come about from an increase in ad

so there's no surprise that in the

during the Great Depression this became

quite a quite a successful Theory quite

a a popular Theory to adopt for those

reasons there and um it takes away the

major issue of the classical model the

major limitation which is well when is

the long run when does the long run

occur there is no time frame put on it

when the wages become variable if they

become variable it takes away that

limitation and directly the economy can

can uh move towards full employment

level of

output all right so that's the Keynesian

model there taking away the major

limitations of wages the Assumption of

wages how they become variable in the

long term in the classical model hope

that makes sense