AP Macroeconomics Page 1 of 5

Assignment: Apply the Keynesian Model to AD/AS

1. The Keynesian AE model is a basic representation of the economy in a situation

where, for whatever reason, prices don’t change.

A. Show, in an AE diagram, the change in equilibrium Y from a given increase in

autonomous expenditure. (6 points)

B. This simple Keynesian result relies on prices not changing when Y increases. One
reason prices wouldn't change is that input costs don't change. Explain why an
increase in GDP might not lead to increased costs for producers. Hint: The economy
is operating inside the PPF. (5 points)

Since the economy is operating inside the PPF, there are a lot of unused resources
in the economy. Thus, it is easier for producers to increase production without
increasing the costs.

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AP Macroeconomics Page 2 of 5
Assignment: Apply the Keynesian Model to AD/AS

2. A typical AS curve has three parts: a flat, horizontal portion at low levels of output, a
middle section with a more-or-less gentle upward slope, and a steep or vertical
portion at high levels of output. Let’s consider two of these parts individually, the
horizontal portion and the vertical portion.

A. Imagine that AS and AD intersect in the horizontal portion of the AS curve. Assume
a technological breakthrough increases the full-employment level of RGDP and shifts
the AS curve to the right. In this case, when aggregate supply increases, how does
the output of the economy change? Does supply create its own demand? (5 points)

The output of the economy will not have a significant change, but the price level may decrease since the supply
curve will shift to the right. Supply does not create its own demand.

B. Imagine that AS and AD intersect in the horizontal portion of the AS curve. In this
case, if aggregate demand increases, how does the output of the economy
change? Does demand drive the economy here? (5 points)

The output of the economy increases significantly, but there is little nor no change to price level. Demand does drive
the economy. Production does increase to match the demand increase without increases in prices.

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AP Macroeconomics Page 3 of 5
Assignment: Apply the Keynesian Model to AD/AS

C. Imagine that AS and AD intersect in the vertical portion of the AS curve. In this
case, if aggregate demand increases, how does the output of the economy change?
Does demand drive the economy here? (5 points)

The output does not increase significantly, but the price level increases a lot. No, the demand does not drive the
economy here.

D. Imagine that AS and AD intersect in the vertical portion of the AS curve. Assume a
technological breakthrough increases the full-employment level of RGDP and shifts
the AS curve to the right. In this case, when aggregate supply increases, how does
the output of the economy change? Does supply create its own demand? (5 points)

The output of the economy increases and there is little price change. Yes, the supply creates its own demand.

E. Which part of the AS curve is consistent with the Keynesian model, and which part
of the AS curve is consistent with the classical model? (2 point)

The horizontal part is consistent with the Keynesian model.

The vertical part is consistent with the classical model.

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AP Macroeconomics Page 4 of 5
Assignment: Apply the Keynesian Model to AD/AS

3. Aggregate expenditure equals the sum of consumption, investment, government

spending, and net exports. These are also the components of aggregate demand. The
aggregate expenditure model looks at the effects of changes in demand on income (Y),
assuming that the price level does not change. Likewise, in the flat or Keynesian
portion of the AS curve, the price level will not change when output changes.

A. In an AE model with MPC = 0.80, the government increases spending by $100

million. What will be the increase in equilibrium Y in the Keynesian AE model? (6
points)

Spending multiplier: 1/ ( 1- 0.8) = 5

100 x 5 = 500

$500 million will increase in equilibrium Y.

B. Say you have two graphs of an economy: a graph showing the Keynesian model (as
discussed in part A, above) and another showing the AD/AS model. In the AD/AS
diagram, the AD curve will shift to the right by the amount of the increase in Y
predicted by the Keynesian AE model. If the AD curve intersects the AS curve in the
flat, Keynesian portion of the AS curve, what will be the increase in real output in
the AD/AS model resulting from the $100 million increase in government spending?
(5 points)

The increase in real output will be slightly less than $500 million and there is a little price level increase.

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AP Macroeconomics Page 5 of 5
Assignment: Apply the Keynesian Model to AD/AS

C. Continuing the line of questioning from part B, above, now say the AD curve
intersects the AS curve where the AS is vertical. What will be the increase in real
output in the AD/AS model resulting from the $100 million increase in
government spending? (5 points)

The increase in output will be far below $500 million. However, the increase in price level will be large.

D. If the AD curve intersects the AS curve in the middle section of the AS curve, can
you calculate the increase in real output in the AD/AS model resulting from the
$100 million increase in government spending? If not, what additional information
would you need? (6 points)

You cannot calculate the increase in real output in the AD/AS model resulting from the $100 million increase in
government spending. You would need additional information to calculate this such as how much investment there
is, the net exports, consumption, and the taxes that are paid in addition to the spending multiplier.

E. In general, what effect does the slope of the AS curve have on the size of the change
in real output due to an increase in autonomous expenditure in the AE model? (5
points)

When the slope is in the vertical portion, the change in real output will be really small.
When the slope is in the horizontal portion, the change in real output will be large.

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