Question

Price Level LRAS SRAS 125 -- AD2 120 i E11 - AD 12.0 12.2 Real GDP in Trillions Does the graph above reflect a Classical Model or a Keynesian Model? How do you know? What is happening in this economy in the short run? Note: This is nit a group discussion. All posts must be made individually.

Answer 1

The graph above reflects a classical model because the classical view is that long run aggregate supply is perfectly inelastic, where Keynesian view of LRAS is different. According to the Keynesian theory, economy can be below full capacity in the long run. But classical model argues in long run a faster growth in the AD compared to the SRAS will increase inflation but real GDP won't change. In classical model, LRAS is shown by a vertical line.

In the short run, where AD2 and SRAS intersects, equilibrium real GDP is $12.2 trillion which is greater than long run potential GDP of $12 trillion. Therefore, in short run the economy experiences an inflationary gap of $(12.2 - 12) trillion = $0.2 trillion.