Courses : Intermediate Macroeconomics Lecturer : Frischa Adellia Semester : 4th Semester, 2022/2023 Sesion The Keynesian Aggregate Supply Model The Keynesian aggregate supply model, also known as the horizontal aggregate supply model, differs from the classical model in that it does not assume that the aggregate supply curve is always straight and vertical. This model assumes that at a certain price level, aggregate supply will remain constant until the maximum production capacity is reached. However, after the maximum production capacity is reached, aggregate supply will become inelastic, which means an increase in price will not induce a larger aggregate supply. The Keynesian aggregate supply model also emphasizes the importance of aggregate demand in determining the level of output and prices in the market. Keynesian noticed that when aggregate demand decreases, there will be a decrease in aggregate supply and production. Conversely, when aggregate demand increases, aggregate production and supply will increase. The Keynesian aggregate supply model also assumes that the labor market does not always reach equilibrium. In this model, the unemployment rate can be high even when the economy is operating above its maximum productive capacity. The Keynesian aggregate supply model is more suitable for explaining the short run of the economy, especially in situations where production capacity has not yet reached a maximum. This model also takes into account factors such as government policies and the influence of macroeconomic variables such as unemployment rates, inflation, and fiscal and monetary policies. However, the Keynesian aggregate supply model also has its critics, including: 1. Lack of concern for production costs: This model ignores the role of production costs in determining aggregate supply. 2. Lack of concern for industry structure: This model ignores the role of industry structure in determining aggregate supply. 3. Lack of concern for market efficiency: This model ignores the role of market efficiency in determining aggregate supply. Therefore, the Keynesian aggregate supply model also needs to be developed and updated to take these factors into account and provide a more complete understanding of economic behavior. The Keynesian aggregate supply model is a macroeconomic model that explains how the economy reacts to changes in aggregate spending in the short run. In this model, aggregate supply is affected by different factors than in the classical model, such as wage rates and fiscal policy. The Keynesian aggregate supply model assumes that in the short run, wage levels are fixed and that firms cannot instantly adjust their prices to cope with changes in demand. Therefore, aggregate supply in the short run is influenced by factors other than production costs, such as the level of government spending and the level of private investment. In this model, aggregate supply can be given by the following equation: Y = Yf + a (P-Pe) Where: • Y is the real output • Yf is the potential output or output that might be achieved if the economy works at full employment level • P is the current price level • Pe is the expected price level • a is a parameter that measures the sensitivity of real output to changes in the price level (also called the elasticity of aggregate supply) In the Keynesian aggregate supply model, aggregate supply in the short run is elastic, meaning that changes in the price level can affect real output significantly. In the long run, aggregate supply becomes inelastic because firms can adjust their production costs accordingly. In this model, fiscal and monetary policies can be used to influence the level of aggregate spending and, therefore, affect the output level and price level in the short run. Keynesianism views that the government has an important role in controlling the economy and can use fiscal policy to overcome the problem of unemployment and economic slowdown. In the Keynesian aggregate supply model, aggregate production is seen as a function of the total aggregate demand in the economy. This model is based on the principle that aggregate supply is elastic in the short run, that is, production can increase or decrease in response to changes in aggregate demand. In this model, there are three different levels of aggregate production: the full level, the above full level, and the below full level. The full level achieves the maximum output that can be achieved with the available factors of production, while the above full level achieves higher output than the full level by making use of more intensive production factors. Underfull rates, on the other hand, result in output that is less than full levels due to market imperfections and unemployment. The Keynesian aggregate supply model assumes that prices and wages are relatively fixed in the short run. Therefore, a change in aggregate demand that is higher than the full level will only affect the amount of aggregate production, but will not affect prices. In general, the Keynesian aggregate supply model views the economy as not always at full capacity. In conditions of unemployment, an increase in aggregate demand will encourage an increase in aggregate production, but in full or above full conditions, an increase in aggregate demand will only trigger an increase in prices without increasing aggregate production.