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Principles of economics openstax chapter25

# Chapter Title
25 The Keynesian
PowerPoint Image Slideshow

Figure 25.1

Home foreclosures were just one of the many signs and symptoms of the recent Great
Recession. During that time, many businesses closed and many people lost their jobs.

Business cycles

The chart tracks the percent change in GDP since 1930. The magnitude of both recessions and
peaks was quite large between 1930 and 1945.

Keynesian Aggregate Supply

The Keynesian View AS is horizontal at levels of output below potential and vertical at potential output.
At potential output, any decrease in AD causes GDP to decline with no change in the price level.

The Keynesian View: Wage Rigidity

Wages are “rigid” or “sticky” downward.

Sticky Wages refers to the downward rigidity of wages as an explanation for
the existence of unemployment.
At less the full employment, sticky wages results in sticky prices.

The Keynesian View: Wage Rigidity

In a recession, the demand for labor and the demand for goods and services
In the labor market, sticky wages cause excess supply of labor or
In the product market, sticky prices cause excess supply of goods and

The Keynesian View: Wage Rigidity

The Keynesian View: Wage Rigidity

Sticky wages are mostly set by labor unions and work contracts in mid-wage occupations. Data in
the aftermath of the Great Recession suggests that jobs lost were in mid-wage occupations, while
jobs gained were in low-wage occupations.

Economy at less than full employment

Demand policy to bring about recovery

Expansionary fiscal and monetary policies will give rise to the AD, increasing GDP and price
level to eventually reach full employment.

Unemployment and Inflation

The relationship between aggregate output and general price
level is positive as described by short-run AS.

When the economy produces more output to reach its potential,
employment and general price level keeps rising.

The relationship between unemployment and price level is
negative. When the economy produces more output to reach its
potential, unemployment declines while general price level keeps

The Phillips Curve

The relationship between inflation rate and unemployment rate.

It shows that there is a trade-off between
inflation and unemployment. To lower the
inflation rate, we must accept a higher
unemployment rate.

The Phillips Curve

At point A illustrates an inflation rate of 5% and an unemployment rate of 4%. If the government
attempts to reduce inflation to 2%, then it will experience a rise in unemployment to 7%, as shown at
point B.

The Phillips Curve

In the 1960s, inflation appeared to respond in a
fairly predictable way to changes in the
unemployment rate.
Inflation in the 1960s was “demand-pull.”

The Phillips Curve

But in the 1970s- 1990s, the Phillips
Curve broke down.

The points on this figure show no
particular relationship between
inflation and unemployment rates.

Inflation was both cost-push and

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The acceleration hypothesis

A government attempt to move the economy beyond potential GDP is only inflationary as workers
eventually get their wages adjusted for price increases. The economy will stabilize at potential GDP
with rising prices.


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