Question

If the economy is operating in the Keynesian zone of the SRAS curve and aggregate demand falls, what is likely to happen to real GDP?

Short answer

In the Keynesian zone of the SRAS curve, when aggregate demand falls, the real GDP also falls due to reduced production levels, as the demand for goods and services decreases. The price level remains constant in this zone, and the reduction in real GDP indicates that the economy moves deeper into the recession.

Step-by-step solution

Understand the Keynesian Zone of the SRAS Curve

The SRAS curve shows the relationship between the price level and real GDP supplied in the short run. The curve can be divided into three zones: Keynesian, Intermediate, and Classical. The Keynesian zone represents a situation where the economy is in a recession or depression. In this zone, the SRAS curve is horizontal or almost flat, which indicates that the prices are, for the most part, constant or fixed in the short term.

Understand Aggregate Demand

Aggregate demand represents the total demand for goods and services in an economy. It is determined by factors such as consumption, investment, government spending, and net exports. A decrease in aggregate demand means that the demand for goods and services has fallen, which can be caused by factors such as lower consumer spending, reduced business investments, or decreased government spending.

Visualize the Initial Situation

To analyze the impact of a decrease in aggregate demand on real GDP in the Keynesian zone, let us first visualize the initial situation. In the Keynesian zone of the SRAS curve, the economy is in a recession with low real GDP and a flat SRAS curve. The aggregate demand curve is downward-sloping, intersecting the SRAS curve at an equilibrium point that determines the initial level of real GDP and price level in the economy.

Analyze the Impact of a Decrease in Aggregate Demand

When aggregate demand falls, the aggregate demand curve shifts to the left. In the Keynesian zone, the SRAS curve is flat, indicating that the prices are fixed in the short term. As a result, the fall in aggregate demand does not lead to a decrease in the price level. Instead, it directly affects the real GDP. Because the demand for goods and services has fallen, the production levels also decrease, leading to a reduction in real GDP.

Determine the Outcome

In the Keynesian zone of the SRAS curve, when aggregate demand falls, the real GDP also falls as the decrease in demand for goods and services leads to reduced production levels. Since the SRAS curve is flat in this zone, the price level remains constant, and the reduction in real GDP indicates that the economy moves deeper into the recession.