Chapter 15, Problem 1E

To determine

To explain:

The dissimilarity between new and old Keynesian economics.

Explanation of Solution

Old Keynesian theory states that, to increase the equilibrium Gross Domestic Product, one must change the aggregate demand and move it towards right where the prices are constant. The old Keynesian theory asks to fix the equilibrium Gross Domestic Product. Hence, to fix it the government intervenes and increases the equilibrium GDP by increasing the demand or shifting the aggregate demand curve towards the right.

The figure below represents the Old Keynesian model where,aggregate supply curve AS is horizontal and change in aggregate demand curve shifts from ${\text{AD}}_{\text{1}}\text{to}{\text{AD}}_{\text{2}}$ and changes the equilibrium Gross Domestic Product.

New Keynesian's economists believe that wages and prices are not flexible in the shortrun. According to them, the aggregate supply curve is horizontal at lower levels of output and moves upwards with an increase in output. They also believed that the intervention of government is necessary to maintain the equilibrium Gross Domestic Product.

The figure below represents the New Keynesian's Model where the aggregate supply is horizontal at only lower level of outputs.

Economics Concept Introduction

Keynesian economics:

This theory of economics is about the aggregate demand in the economy and its impact on inflation. The theory explains that the change in aggregate demand is due to the anticipated or unanticipated factors. It has a direct impact in short run on the output and not on the prices. Keynesian believed that the intervention of government in the economy is necessary to stabilize the output.