Question

1. Consider the Keynesian view of economics.
   1. Discuss the main assumptions of the Keynesian school of thought in macroeconomics
2. 2. Assume a recession. Using the AS-AD framework, explain how Keynesians believe the economy can get out of a recession. Use graphs and words and discuss.

Answer 1

a)Keynesian economics relies on main three assumptions , rigid prices , effective demand and saving-investment determinants. Rigid prices stops markets from achieving equilibrium in the short run,effective demand implies that consumption depends on actual income ,saving and investment determinant include expectations, income, other than interest rate.These assumptions state that an economy can attain short run equilibrium at less than full employment level of production.

b)A recession means fall in real GDP. It is a period of negative growth for two quarters.Recession is caused by a fall in aggregate demand. It is also caused when rise in oil prices increases cost of production and as a result supply curve shifts to the left. During recession real GDP is less than potential GDP.

.Keynesians believe that higher government spending can shift the AD curve to the right and help the economy to come out of recession.During recession when unemployment is high and businesses have low profit , tax cuts also help in taking the economy out from recession.In the graph the original equilibrium is at Eo when the economy is in recession.Increased government spending will shift the AD curve to the right.At the new equilibrium E1,real GDP rises and unemployment falls .Thus Keynesians advocate high government spending to come out of recession