1. Chapter 25 The Keynesian Perspective
Principles of Economics
Chapter 25 The Keynesian Perspective
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2. 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.

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

4. 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.

5. 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.

6. The Keynesian View: Wage Rigidity
In a recession, the demand for labor and the demand for goods and services decline.
In the labor market, sticky wages cause excess supply of labor or unemployment.
In the product market, sticky prices cause excess supply of goods and services.

7. The Keynesian View: Wage Rigidity

8. 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.

9. Economy at less than full employment

10. 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.

11. 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 rising.

12. 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.
Notice that the percentage change in the price level is on the vertical axis, not the price level (P) itself.
The theory behind the Phillips Curve is somewhat different to the theory behind the AS curve, although the insights gained from the AS/AD analysis regarding the behavior of the price level also apply to the behavior of the inflation rate.

13. 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.

14. Inflation in the 1960s was “demand-pull.”
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.”

15. 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 demand-pull.
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16. 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.