keynesian models?

Question

this a question in part of last year test in my school, i need to no the answer to this question, as i am revicing for my test. the question goes like this "keynesian model are only appropraite when actual output is less than potential output" it is a true or false question, then followed by littel expalnation to prove the answer. SOMBODY PLS HELP!!!

Answer 1

Keynesian economics has to do with affecting the 'demand side' of the market; for example increase in government spending will increase demand for goods.

The key, in your question is the gap between 'actual' and 'potential' output.

Potential output is the output the economy could produce if all the factors were fully employed, also known as the full-employment levelof output. In an Aggretate demand/supply diagram, this is a vertical supply curve, because it doesn't matter how much more is demanded, since all factors all fully employed, the economy cannot produce more, and the result will be an increase in prices only.

'Actual' output is the output level where the current Aggregate Demand and Aggregate Supply CUrves meet now.

Your question states that Actual output is lower than potential output. Visually, the AD and AS meet to the left of the FullEmp Output.

Keynesian policies, such as increase in government spending, would increase Aggregate DEmand at all prices, a rightward shift in the AD curve. If done properly, the new demand curve intersects the current AS curve and the FullEmp Output.

Therefore the Keynesian policy has achieved full employment, at the expense of some increase in prices. How big is the increase in price depends on the slope of the AS curve. The steeper it is, the higher the price increase.

Now, if originally the economy was already at the point where actual output equals potential output. Then in the short run, as the Keyneisan policies kick in, there will be a time where actual output exceeds potentiel output. That's due to stuff like overtime and so on. But this is not a long run equilibrium. Wage pressures will grow in the economy since tehre is huge competition for labour, and thus the costs of production increase, shifting the AS curve up. And long run equilibrium would be AT the original point (output=potential output) but at a much higher price level.

All a Keynesian injection does when potential output = actual outputis to increase prices.

But, on the other hand, a contractionary Keyneisan policy would still work if actual output>potential output. A decrease in AD due to a decrease in Government spending would shift the AD curve left, decreasing prices until potential and actual output are again equated.

So I'd say that expansionary Keyneisan policies work if actual output is less than potential output, and contractionary policies work if actual output exceeds potential output.

Answer 2

Keynes' economic theories were not based on improving potential output as most classical theories (from the 1700s) had been, but were focused on the demand for goods (which he said drove the economy, particularly during downturns). By increasing the actual and/or potential outputs, this will not necessarily help the economy because it creates a surplus of goods or services. Decreases in demand would cause prices to decline, rather than affecting real output and employment. He believed that economic systems would not automatically right themselves to attain "the optimal level of production", and it does not matter if optimal production levels are attained in the long run. Therefore I would say the statement is true. Hope this helps.

Answer 3

Keynesian model emphasis on the demand, and all that would assist towards increasing or decreasing demand would be connected to the keynesian model.

Your question reads:"keynesian model are only appropriate when actual output is less than the potential output".

This refers to the deflatinary gap between the Aggregate demand curve at present, and the Aggregate Demand curve that should be.

But since, this mentions about output, its supply-side policy.