Question

3. From a Keynesian point of view, which is more likely to cause a recession: aggregate demand or aggregate supply, and why? In your answer explain the difference between Keynes law and Say's law. 4. Why do sticky wages and prices increase the impact of an economic downturn on unemployment and recession?

Answer 1

3)

Keynesian explanation stresses on the aggregate demand only. it is related to the short run only. In the short run, a change in aggregate demand would cause economic fluctuations.

During the short run, when there is a fall in aggregate demand, the expenditure would decrease in the economy. It will disincentivize investment and economic activities in the economy.

Hence, the government through its fiscal policy must increase expenditure and reduces taxes when demand is deficient in the economy. Deficient demand can be remedied through government actions.

Say law on the other hand, does not recommend government actions in economic activities. There must be minimum actions of governments in economic activities. Market forces work efficiently and equilibrium is automatically restored in the economy. Supply creates its own demand, thus the government should not unnecessarily involve in economic activities.

4)

Classical economists suggest that flexible wage and price help to restore equilibrium in the economy. If the wage is flexible, the fall in aggregate demand would cause a fall in wage rate and firms would continue to employ the same number of workers. Thus, if wages and prices are left flexible, then there would be equilibrium in the economy.

But Keynes does not agree with classical prescriptions and arguments. He contends that wage and prices are rigid, hence, equilibrium is not restored automatically in the economy.

Thus, sticky wage and price do not restore equilibrium and recession becomes worse.