Question

"In the simple Keynesian model, increases in \(A D\) that occur below Real GDP will have no effect on the price level." Do you agree or disagree with this statement? Explain your answer.

Short answer

Agree. In the simple Keynesian model, an increase in AD that happens below Real GDP will not have an immediate effect on the price level because prices are considered sticky and do not respond rapidly to changes in AD.

Step-by-step solution

Understand the Keynesian Model

The Keynesian model emphasises the total spending in the economy (Aggregate Demand) and its effects on output and inflation. The model proposes that changes in aggregate demand, whether anticipated or unanticipated, have their most significant short-run effect on real output and employment, not on prices.

Understand the Concepts: Real GDP and AD

Real GDP is the market value of all goods and services produced within a country at constant prices. Aggregate Demand (AD) is the total demand for all goods and services within a certain time and price.

Analyzing the effect of AD on price level

According to Keynesian economics, when Aggregate Demand increases, and it's below Real GDP, it generally leads to an increase in Real GDP as firms will increase their output to meet the excess demand. However, it would not have an impact on the price levels. This is because in the Keynesian model, prices are considered to be sticky and hence do not respond quickly to changes in AD.

Conclusion on the statement

In summary, according to the simple Keynesian model, the statement is correct. An increase in AD that occurs below Real GDP will not have an immediate effect on the price level.