Question

Explain why the short-run aggregate supply curve might be fairly flat in the Keynesian zone of the SRAS curve. How might we tell if we are in the Keynesian zone of the AS?

Short answer

The short-run aggregate supply (SRAS) curve might be fairly flat in the Keynesian zone due to the presence of underutilized resources such as labor and capital. In this zone, the economy operates below its full capacity, allowing producers to increase their output without significant increases in input costs. As a result, modest increases in price levels have little impact on output. To determine if an economy is in the Keynesian zone, we can assess factors such as high unemployment rates, low capacity utilization rates, and a negative output gap, which indicate ample room for output growth without substantial price increases.

Step-by-step solution

1. Understanding Aggregate Supply (AS)

Aggregate supply is the total quantity of goods and services that producers in an economy are willing and able to supply at various price levels, holding all else constant. The short-run aggregate supply (SRAS) curve depicts the positive relationship between the price level (inflation) and the quantity of goods and services supplied in the short run.

2. Zones of the SRAS Curve

The SRAS curve can be divided into three zones: Keynesian, Intermediate, and Classical. In the Keynesian zone, the curve is fairly flat, implying that changes in the price level have little impact on the quantity of goods and services supplied. In the Intermediate zone, the SRAS curve becomes steeper, indicating that changes in the price level have a more significant impact on output. Finally, in the Classical zone, the SRAS curve is nearly vertical, suggesting that the economy is operating at full capacity and output is not responsive to changes in the price level.

3. Explaining the Flat SRAS curve in the Keynesian Zone

In the Keynesian zone, the economy operates below its full capacity, meaning there are unused resources (e.g., labor and capital). As a result, producers can increase their output without significant increases in input costs. This leads to a relatively flat SRAS curve in the Keynesian zone, as modest increases in price levels will not lead to significant increases in output. Moreover, there might be excess capacity and unemployment during a recession, allowing the economy to expand without causing inflationary pressures.

4. How to Tell If We Are in the Keynesian Zone

To determine if an economy is in the Keynesian zone of the AS curve, we can assess factors such as the unemployment rate, the capacity utilization rate of industries, the output gap, or even the shape of the SRAS curve itself. For instance, high unemployment rates and low capacity utilization rates could signify that an economy is in the Keynesian zone, where there is ample room for output growth without substantial price increases. Additionally, if the output gap is negative (actual GDP is below potential GDP), it can indicate that the economy is in the Keynesian zone and has a slack in resources that could be utilized to boost aggregate supply without causing inflation. In conclusion, the Keynesian zone of the SRAS curve represents an economy operating below its full capacity, where resources are underutilized and output growth is not significantly impacted by price level changes. To determine if an economy is in this zone, we can consider indicators such as the unemployment rate and capacity utilization rates, as well as the shape of the SRAS curve.