Keynesian and Supply Side Diagrams How to Draw and Use Keynesian and Supply Side Diagrams

Keynesian Aggregate Supply Curve- Step 1 Price Level What is Keynes’ Law of Markets? P Total Demand and Supply Quantities D, y

Keynesian Aggregate Supply Curve- Step 1 Price Level What is Keynes’ Law of Markets? P What will producers adjust faster, prices or quantities produced? Total Demand and Supply Quantities D, y

Keynesian Aggregate Supply Curve- Step 1 Price Level What is Keynes’ Law of Markets? P What will producers adjust faster, prices or quantities produced? How do you draw rapid quantity adjustments with no price adjustment? Total Demand and Supply Quantities D, y

Keynesian Aggregate Supply Curve- Step 1 Price Level What is Keynes’ Law of Markets? P What will producers adjust faster, prices or quantities produced? How do you draw rapid quantity adjustments with no price adjustment? Keynes’ Law of Markets Segment of Aggregate Supply Curve Total Demand and Supply Quantities D, y

Keynesian Aggregate Supply Curve- Step 2 Price Level P But what happens if the economy approaches the wall of full employment? The Wall Yf.e. Full Employment Level of GDP D, y

Keynesian Aggregate Supply Curve- Step 2 Price Level P But what happens if the economy approaches the wall of full employment? And certain sectors begin to run out of raw materials, excess capacity, and labor with critical skills? The Wall Yf.e. Full Employment Level of GDP D, y

Keynesian Aggregate Supply Curve- Step 2 Price Level P But what happens if the economy approaches the wall of full employment? And certain sectors begin to run out of raw materials, excess capacity, and labor with critical skills? Will the businesses in those sectors be able to just increase the amounts they produce? The Wall Yf.e. Full Employment Level of GDP D, y

Keynesian Aggregate Supply Curve- Step 2 Price Level P But what happens if the economy approaches the wall of full employment? And certain sectors begin to run out of raw materials, excess capacity, and labor with critical skills? Will the businesses in those sectors be able to just increase the amounts they produce? The Wall What will companies have to do if they’re faced with increased orders from customers and their costs of raw materials and labor are rising dramatically? Yf.e. Full Employment Level of GDP D, y

Keynesian Aggregate Supply Curve- Step 2 Price Level P Faced with shortages of inputs and strong orders, companies in critical sectors will be forced to begin raising prices. The Wall Yf.e. Full Employment Level of GDP D, y

Keynesian Aggregate Supply Curve- Step 3 Price Level P And if demand in the economy were to continue to rise, other companies would face rising input costs, shortages of raw materials and labor. They, too, would join in and raise prices. The Wall Yf.e. Full Employment Level of GDP D, y

Keynesian Aggregate Supply Curve S=( Aggregate Supply) P The Wall Yf.e. D, y (quantities)

Supply-Side Economics Aggregate Supply Curve Price Level P What law of markets is behind Supply-Side Economics? Aggregate Demand or Supply D, y (quantities)

Supply-Side Economics Aggregate Supply Curve Price Level P What law of markets is behind Supply-Side Economics? According to Say’s Law of Markets, what will suppliers adjust faster, quantities produced or prices? Aggregate Demand or Supply D, y (quantities)

Supply-Side Economics Aggregate Supply Curve Price Level P If companies adjust prices much faster than the quantities of stuff they produce, how do you draw the aggregate supply curve? Aggregate Demand or Supply D, y (quantities)

Supply-Side Economics Aggregate Supply Curve Price Level P S=Aggregate Supply Say’s Law- prices adjust faster than quantities produced Q’s p r i c e s Aggregate Demand or Supply D, y (quantities)

Supply-Side Economics Aggregate Supply Curve Price Level P S=Aggregate Supply Aggregate Demand or Supply D, y (quantities)

Supply-Side Economics Aggregate Supply Curve Price Level P S=Aggregate Supply Aggregate Demand or Supply D, y (quantities)

Keynesian or Supply-Side Aggregate Demand Curve If prices are very high, will demanders be willing and able to buy very much? P Quantities demanded D, y

Keynesian or Supply-Side Aggregate Demand Curve If prices are very high, will demanders be willing and able to buy very much? P But if prices of stuff were to fall, everything else equal, what will happen to demanders’ ability and willingness to purchase stuff? Quantities demanded D, y

Keynesian or Supply-Side Aggregate Demand Curve When prices fall, People will be willing and able to buy larger quantities of stuff D= Aggregate Demand Quantities demanded D, y

Keynesian or Supply-Side Aggregate Demand Curve D= Aggregate Demand Quantities demanded D, y

Why does one Keynesian demand curve rise and the other one fall? Demand’s relation to Y Demand’s relation to Price Level D D P D D or y Y Hint: Note what is being placed on the axes.

Why does one Keynesian demand curve rise and the other fall? As income rises, people can spend more As price level falls, people can buy larger quantities of stuff. D D P D rises As P falls As Y rises Ability to buy stuff rises D D or y Y

Keynesian View of an Increase in Investment Spending What is the prime mover of the macroeconomy according to Keynes?

Keynesian View of an Increase in Investment Spending What is the prime mover of the macroeconomy according to Keynes? How will an increase in investment feed through the economy from the Keynesian perspective?

Keynesian View of an Increase in Investment Spending What is the prime mover of the macroeconomy according to Keynes? How will an increase in investment feed through the economy from the Keynesian perspective? How do you show the effects on an aggregate demand and supply diagram (with P on the vertical axis and D & y on the horizontal?)

Results: if I goes up during a recession, real GDP will rise without any inflation of Prices

Results: if I goes up when the economy is near the wall, real GDP and Prices will rise

Supply-Side View of an Increase in Investment What is the prime mover of the macroeconomy?

Supply-Side View of an Increase in Investment What is the prime mover of the macroeconomy? How will investment in new equipment and technology affect the supply capacity of the economy?

Supply-Side View of an Increase in Investment What is the prime mover of the macroeconomy? How will investment in new equipment and technology affect the supply capacity of the economy? Which way will the aggregate supply curve shift? Show on an aggregate demand and supply diagram

Supply-Side Economics : effects of an increase in Investment S before P S after increase in I P1 P2 D y1 y2 D, y Results: Investment creates more supply, and with the extra supply, producers will adjust prices downwards so lower P and increased y

Keynesian Tax Policy During Inflationary Periods If an inflation is happening, what should the Federal Government do to taxes? Show how this is supposed to work on a Keynesian diagram (P on vertical, D or y on horizontal axis)

Results: Demand decreasing policies can prevent inflation from taking hold

Supply-Side View of a Tax Increase How will a tax increase affect the supply capacity of the economy?

Supply-Side View of a Tax Increase How will a tax increase affect the supply capacity of the economy? What will happen to peoples’ desire to work overtime if there is a high marginal tax on the extra earnings?

Supply-Side View of a Tax Increase How will a tax increase affect the supply capacity of the economy? What will happen to peoples’ desire to work overtime if there is a high marginal tax on the extra earnings? How will this affect the position of the aggregate supply curve? What will happen to inflation, real GDP?

Supply-Side Economics : effects of an increase in taxes S after P S before tax increase P2 P1 D y2 y1 D, y Results: Tax Increases Reduce the Supply Capacity of the Economy, thereby causing Prices to Rise and real y to fall. Stagflation

Supply-Side View of a Tax Increase How will a high profits tax affect the supply capacity of the economy?

Supply-Side View of a Tax Increase How will a high profits tax affect the supply capacity of the economy? What will happen to a company’s ability to develop new technologies and invest in productivity enhancing equipment?

Supply-Side View of a Tax Increase How will a high profits tax affect the supply capacity of the economy? What will happen to a company’s ability to develop new technologies and invest in productivity enhancing equipment? How will this affect the position of the aggregate supply curve? What will happen to inflation, real GDP?

Supply-Side Economics : effects of an increase in profits taxes S after P S before tax increase P2 P1 D y2 y1 D, y Results: Tax Increases Reduce the Supply Capacity of the Economy, thereby causing Prices to Rise and real y to fall. Stagflation

Supply-Side View of a Tax Increase How will a high tax rate on interest income affect peoples’ desire to save?

Supply-Side View of a Tax Increase How will a high tax rate on interest income affect peoples’ desire to save? What will happen to the total savings in the country if there’s a high tax on savings?

Supply-Side View of a Tax Increase How will a high tax rate on interest income affect peoples’ desire to save? What will happen to the total savings in the country if there’s a high tax on savings? How will low savings affect interest rates?

Supply-Side View of a Tax Increase How will a high tax rate on interest income affect peoples’ desire to save? What will happen to the total savings in the country if there’s a high tax on savings? How will low savings affect interest rates? The ability of corporations to get funds to invest? How will this affect the position of the aggregate supply curve? The macroeconomy?

Supply-Side Economics : effects of an increase in taxes on savings S after P S before tax increase P2 P1 D y2 y1 D, y Results: Tax Increases Reduce the Supply Capacity of the Economy, thereby causing Prices to Rise and real y to fall. Stagflation

What kinds of tax cuts are best from a Supply-Side View?

What kinds of tax cuts are best from a Supply-Side View? Taxes that increase total savings and investment

What kinds of tax cuts are best from a Supply-Side View? Taxes that increase total savings and investment Example 1: capital gains tax cut: this will raise the income of the wealthy, and they have a very high average propensity to save

What kinds of tax cuts are best from a Supply-Side View? Taxes that increase total savings and investment Example 1: capital gains tax cut: this will raise the income of the wealthy, and they have a very high average propensity to save Example 2: corporate profits tax cut: this will allow companies to plow more money back into productivity enhancing activities

Supply-Side Economics : effects of a tax cut that increases savings or investment S before P S after increase in I P1 P2 D y1 y2 D, y Results: Investment creates more supply, and with the extra supply, producers will adjust prices downwards so lower P and increased y

Work out on your own: Compare a Keynesian and Supply-side view of the macro-effects of an oil price increase. Show on diagrams Which theory better explains the late 1990s rapid economic growth, low unemployment rates, and low inflation rates? Show on diagrams