Question

1.

a) On an AD/AS graph, use a Keynesian supply curve to display the impact
of stimulus spending.
b) On an AD/AS graph, use a Classical supply curve to display the impact
of stimulus spending.

Answer 1

COMBINED ANSWER

Aggregate supply curve shows the relationship between aggregate supply of output and price level. In Keynesian theory aggregate supply curve is perfectly elastic. It implies a horizontal supply curve. Keynesian aggregate supply curve reflects the fact that output is less than full employment. In this case unit cost of production remains constant and wage rate remains fixed.

In classical theory aggregate supply curve is perfectly inelastic. Aggregate supply is determined by preference of the workers regarding work and leisure, stock of capital and state of technology. To classicals real variables such as GDP, employment and real wage rates are determined by real factors only. It is called classical dichotomy.

Keynesian theory advocates below full employment level of output along with sticky money wage rate. So more aggregate output is produced and supplied in responds to increase in AD(stimulus spending). But once full employment is reached, further increase in AD leads to increases in price level alone.

The segment pe is the Keynesian aggregate supply curve. Here when AD increases from ADo to AD1, output increases from qo to q1 without any change in price level. Full employment output is q1.The vertical segment is the classical aggregate supply. Here increase in AD leads to Increase in price level only.