1. Inflationary v. Recessionary Gaps Classical v. Keynesian View
“ If Society values full employment as an economic goal, is a capitalist economy inherently capable of achieving that goal without intervention on the part of the government?”

2. Economic Statistics Rules of Thumb
Good  2-3% Inflation Bad
Bad  3-4% Growth (RGDP) Good
Good  4-5% Unemployment Bad

3. Long Run Equilibrium at Full Employment AD = SRAS = LRAS FE Y0
RGDP=Y
Long Run Equilibrium at Full Employment
AD = SRAS = LRAS
Actual GDP (where AD intersects SRAS) = Potential GDP (FE/ LRAS)

4. Classical view of a Recessionary Gap
SRAS0 PL
LRAS
SRAS1
PL0
PL1 AD FE Y0 Y1
RGDP=Y
Classical view of a Recessionary Gap
1. Economy is producing < FE; Actual GDP < Potential GDP
2. # of unemployed > # of job openings
3. W rate is bid down, C of P↓ , shifts SRAS0 to SRAS1
4. PL ? GDP? U?
The economy self adjusts! Equilibrium is restored!

5. Keynesian view of a Recessionary Gap PL
LRAS
SRAS0
PL1
PL0
AD0
AD1 FE Y0 Y1
RGDP=Y
Keynesian view of a Recessionary Gap
1. Economy is producing < FE; Actual GDP < Potential GDP
2. # of unemployed > # of job openings
The economy needs help from the government!
3. Increase G, Increase TP, decrease T, or increase MS to increase AD.
4. PL ? GDP? U?
Equilibrium is restored but what happens to inflation?

6. Classical view of an Inflationary Gap
SRAS1 PL
LRAS
SRAS0
PL1
PL0 AD FE Y1 Y0
RGDP=Y
Classical view of an Inflationary Gap
1. Economy is producing beyond FE; Actual GDP > Potential GDP
2. # of unemployed < # of job openings
3. W rate is bid up, C of P ↑, shifts SRAS0 to SRAS1
4. PL ? GDP? U?
The economy self adjusts! Equilibrium is restored but…!

7. Keynesian view of an Inflationary Gap
SRAS1 PL
LRAS
SRAS0
PL0
PL1
AD1
AD0 FE Y1 Y0
RGDP=Y
Keynesian view of an Inflationary Gap
1. Economy is producing beyond FE; Actual GDP > Potential GDP
2. # of unemployed < # of job openings
The economy needs help from the government!
3. Decrease G, , decrease TP, increase T, or decrease MS to reduce AD.
4. PL ? GDP? U?
Equilibrium is restored but what happens to GDP and U?