Question

Describe the effects, according to both views (Classical and Keynesian), of an increase in the money supply. Explain what happens to real output and the price level. Use the AD-AS model diagram to discuss the effects.     

Answer 1

The classical economic model has the following features-

1. The economy is at full employment.
2. Prices adjust freely and there are no restrictions on the upper or lower levels. They’re completely flexible.
3. There’s no government intervention

The Keynesian economic model has the following features-

1. Government intervention and policies are required to maintain the stability in the economy.
2. Monetary and fiscal policies are greatly suggested by the Keynes model.
3. The economy does not stay at full employment level always.

Effect of classical Model –

Classical AS curve is vertical at the full employment level and does not intend to change from that level. It says that the economy will operate on this level only, may it have different price levels. Thus, the equilibrium stands at full employment level of the economy. Prices may move up or down but the production will remain the same.

According to this model, the economy will remain stable or move back to stability automatically if there’s any downturn of the economy in future.

The aggregate demand curve stays the downward sloping curve.

Pauce AS Clasical Model AD oustput

Effect of Keynesian Model –

The model got introduced immediately after the great depression. According to the model, the economy is not at full employment level. The unemployment was very high and the people were losing jobs at a greater number because of aftereffects of the recession. The prices are flexible and the output is also adjustable according to Keynes. The aggregate demand curve and aggregate supply curve are as follows-

Phics AS kugoesions Model AD Cutput