TOPIC 4-1: INTRODUCTION TO THE KEYNESIAN

MODEL

Short-run tools - Graphing basics

• AD-AS
• Keynesian cross

a. Aggregate Demand

P = price level, an average

for all goods and services; a
price index (the best price
index would be the GDP
deflator)
Y = total expenditure/
income/ output
• AD curve: shows total amount of expenditures of
economy at specific levels of prices, given the
spending resources economy has at its disposal
• Downward (or negative) slope: the higher the
price level, the less quantity of goods and services
the economy’s spending resources can buy
b. The Keynesian Cross
• The Keynesian cross is the graph that
corresponds to the Keynesian model of
aggregate demand - the C+I+G+NX equation, a
“short-run” model that assumes that prices are
not changing. More often, we will be using the
earlier AD-AS tool more so we can graphically
introduce price changes.
*Underlying assumption: Price can be ignored
*Since expenditures equal output (= incomes), AD=Y is
on the 45o line.

Movements and shifts in the AD

c. Aggregate Supply

• Movements along the AD curve – relationship

between Y and P
Y = total output of the
• Shifts in the AD curve – any change in autonomous
economy’s productive
C, I, G, X, M will shift the aggregate demand curve
sector
not coming from price.

• AS curve: shows the quantity of g & s that

producing units together will be willing to supply at
specific levels of prices.
• In the graph, we assume an upward or positive
sloped AS – the higher the price, the greater the
sector will produce and sell.
Movements and shifts in the AS
• Movements along the AS curve – relationship between
Y and P
• Shifts in the AS curve – any change in technical inputs
and input efficiency, technology, other factors like
weather.
However, the application of the model to real
world changes of macroeconomic variables will
require that we understand what is happening
behind our graphs and equations.
• It will also be partial equilibrium analysis – we’ll
take one shock at a time and assume other
variables remain equal, unchanging, ceteris
paribus

CAUTION: DO NOT MIX AD AND AS SHOCKS

AD Shock

AS Shock

Another example of economic “shocks” or “stimulus

affecting AS. Assume an initial state.
• While the pandemic is going on, the swine flu
is back in some provinces in the country.

Upward/shift to the left

of AS (lower Y, higher P)

d. When AD meets AS graphically:

• The economy is in an initial

state of equilibrium.
• A negative stimulus shocks it
out of the equilibrium.
• Always of interest to us:
How does the final compare
to the initial equilibrium?

• We’ll use comparative statics – a comparison

of two equilibrium states pre- and post
adjustment to a shock. Comparative statics
does not look at the process of adjustment.