Keynes Model

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Keynes Model

• Penultimate week

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Insight 1

• we map output against inflation output on
  horizontal, inflation on vertical.
• Higher inflation leads to lower output, therefore
  Aggregate demand (AcYIG) slopes downward.

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Aggregate Demand
Inflation
AD
Output (Y)
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Aggregate Supply

• Slopes upwards (Higher income leads to demand
  pull and cost push inflation)
• Might be vertical if prices adjust fully
• Will be vertical in long run

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Short run without full adjustment
Inflation
AS
AD
Output (Y)
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AS with full adjustment
AS
Inflation
AD
Output (Y)
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Policy Example 1
AS
Inflation
AD
AD
An increase in AD leads to higher output and
prices
Output (Y)
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Stagflation (2008?)
AS
Inflation
AS
AD
Output (Y)
Fall in AS leads to higher prices and lower output
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Long Run AD/AS
AS
Inflation
AD
AD
LR capacity is fixed therefore attempts to raise
AD just lead to higher prices.
Output (Y)
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Endogenous Growth
AS
AS
Inflation
AD
AD
Investment in supply side factors can increase LR
capacity.
Output (Y)
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Does the model work

• Its good enough to get an insight.
• Itll get about 70 of the way there (And can be
  refined)
• But it has major weaknesses.
• In particular, the shape of AS and what we can do
  about it is still controversial.