Question

From a Keynesian point of view, which is more likely to cause a recession: aggregate demand or aggregate supply, and why?

Short answer

From a Keynesian perspective, a recession is more likely to be caused by a decrease in aggregate demand rather than a decrease in aggregate supply. This is because Keynesian theory emphasizes the demand side of the economy and its influence on economic output and employment levels. Insufficient demand can lead to lower output, increased unemployment, and ultimately, a recession. Conversely, a decrease in aggregate supply would likely result in inflation or reduced economic output, but not necessarily a recession.

Step-by-step solution

1. Understanding the Keynesian Theory

Keynesian economics, developed by John Maynard Keynes, primarily focuses on the demand side of the economy and emphasizes the central role of aggregate demand in determining economic output and employment levels. The basic principle of Keynesian economics is that if there is not enough demand for goods and services in an economy, it can lead to unemployment and a recession. Hence, the government should intervene and increase the total demand through fiscal policies, such as increasing government spending and reducing taxes.

2. Aggregate Demand and Aggregate Supply

According to the Keynesian model, there are two main forces influencing economic output: Aggregate Demand (AD) and Aggregate Supply (AS). - Aggregate Demand: It represents the total demand for goods and services in an economy at different price levels. It includes components such as consumption, investment, government spending, and net exports. The AD curve has a negative slope, which means that as the price level increases, the quantity of goods and services demanded decreases. - Aggregate Supply: It represents the total supply of goods and services in an economy at different price levels. There are two types of aggregate supply curves: short-run and long-run. The short-run aggregate supply (SRAS) curve has a positive slope, meaning that as the price level increases, the quantity of goods and services supplied also increases. The long-run aggregate supply (LRAS) curve is vertical, indicating that in the long run, the total supply of goods and services is determined by an economy’s production capacity and is not affected by the price level.

3. Keynesian View on Recession Causes

In the Keynesian framework, a recession is more likely to be caused by a decrease in aggregate demand rather than a decrease in aggregate supply. The reason behind this is that the Keynesian theory is heavily focused on the demand side of the economy and believes that insufficient demand is the primary cause of unemployment and recession. When aggregate demand decreases, it leads to a lower demand for goods and services, thus reducing the level of output and employment. In an attempt to balance the reduced demand, firms might reduce production and lay off workers, which further reduces overall demand in the economy. The decreased spending and high unemployment can then lead to an economic downturn or recession. In contrast, a decrease in aggregate supply could lead to higher prices, reducing the purchasing power of money and discouraging spending. However, this would not necessarily lead to a recession, but rather to inflation or a decrease in economic output. Keynesians believe that demand-driven factors play a more significant role in causing recessions compared to supply-driven factors.

4. Conclusion

From a Keynesian point of view, a recession is more likely to be caused by a decrease in aggregate demand rather than a decrease in aggregate supply. The main reason is the strong emphasis on the demand-side factors and their influence on economic output and employment levels, which could lead to an economic downturn.