Aggregate Demand and Supply

Keynesian AD/AS Model

The Keynesian AD/AS model was developed by economist John Keynes, and simplifies the classical model featuring an AD and AS curve. 

What's are the Elements of a Keynesian AD/AS Model?
  • Price Level (inflation) is on the y axis

  • Real GDP (or economic activity) is shown on the x axis

  • Includes an aggregate demand line represented by AD

  • Short Run and Long Run Aggregate Supply Curves are replaced with a single AS line

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Why is AS curved and LRAS not shown?

The curved AS line removes the need for LRAS line. The LRAS line is used in the classical model to show the position of the economy and whether it is expansionary or contractionary. The curved AS line removes such need, as the line is curved, increases in AD during low levels of real GDP will likely cause little change in price levels while in high levels of real GDP, increases in AD will have a large effect on price levels.

Notice how the increase in real GDP is greater than the increase in price level.

Contractionary Gap on a Keynesian Model

The Keynesian Model above shows a contractionary gap where low levels of economic activity are below what is required at full employment.

As a result, increases in aggregate demand from AD1 to AD2 will cause a small increase in price levels from P1 to P2 but a greater increase in Real GDP from Y1 to Y2. 

Hence, an increase in Aggregate Demand is beneficial in a contractionary gap.

Notice how the increase in price level is larger than the increase in real GDP.

Expansionary Gap on a Keynesian Model

The Keynesian Model above shows a expansionary gap where high levels of economic activity are nearing the level of economic activity at full employment.

As a result, increases in aggregate demand from AD1 to AD2 will cause a large increase in price levels from P1 to P2 but a smaller increase in Real GDP from Y1 to Y2. 

Hence, an increase in Aggregate Demand is not beneficial to the economy in an expansionary gap.

Eventually, the AS becomes a straight line towards the end, emulating the effects of an economy at the Long Run Aggregate Supply Curve.