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Consider an economy in equilibrium with a recessionary gap. Draw a graph where the equilibrium real GDP is $8 trillion and the price level of 150. Label this equilibrium E 1 where the aggregate demand, AD 1 , intersects the short-run aggregate supply curve ( SRAS 1 ). Include in your graph a long-run aggregate supply curve (LRAS) at the full-employment Real GDP level of, say, $12 trillion. a. From a keynesian perspective, what should government do with its fiscal and monetary policies to achieve full employment? How is this expansionary policy reflected in terms of the aggregate demand curve? Illustrate this in your graph. b. Illustrate long-run equilibrium on your graph as E 2 . What has happened to real GDP and the price level as a result of Keynesian policy to achieve full employment in this long run?
Economics For Today
Economics For Today
Consider an economy in equilibrium with a recessionary gap. Draw a graph where the equilibrium real GDP is $8 trillion and the price level of 150. Label this equilibrium E1 where the aggregate demand, AD1, intersects the short-run aggregate supply curve (SRAS1). Include in your graph a long-run aggregate supply curve (LRAS) at the full-employment Real GDP level of, say, $12 trillion.
- a. From a keynesian perspective, what should government do with its fiscal and monetary policies to achieve full employment? How is this expansionary policy reflected in terms of the aggregate demand curve? Illustrate this in your graph.
- b. Illustrate long-run equilibrium on your graph as E2. What has happened to real GDP and the price level as a result of Keynesian policy to achieve full employment in this long run?
(a)
Economy in equilibrium with recessionary gap.
Explanation of Solution
Classical theory and Keynesian theory:
Figure 1, (a) and (b) illustrates classical and Keynesian theories, respectively. The horizontal axis indicates the real GDP of the economy and the vertical axis indicates the general price level.
In part (a), the economy is at short-run equilibrium level E1, where the real GDP is $8 trillion and the price level is 150. However, the economy is in full employment level at E2, where the real GDP is at $12 trillion. Therefore, the economy would experience a recessionary gap. However, the classicals assume self-correcting mechanism in the economy where full employment can be achieved automatically and also, they assume nominal rate and price flexibility.
In Figure 1, part (b) shows Keynesian theory...
(a)
Long-run equilibrium.
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