How to Draw and Use
Keynesian and Supply Side Diagrams
Keynesian Aggregate Supply Curve- Step 1
Price Level
P
What is Keynes’ Law of Markets?
Total Demand and Supply Quantities
D, y
Keynesian Aggregate Supply Curve- Step 1
Price Level
P
What is Keynes’ Law of Markets?
What will producers adjust faster, prices or quantities produced?
Total Demand and Supply Quantities
D, y
Keynesian Aggregate Supply Curve- Step 1
Price Level
P
What is Keynes’ Law of Markets?
What will producers adjust faster, prices or quantities produced?
How do you draw rapid quantity adjustments with no price adjustment?
Total Demand and Supply Quantities
D, y
Keynesian Aggregate Supply Curve- Step 1
Price Level
P
What is Keynes’ Law of Markets?
What will producers adjust faster, prices or quantities produced?
How do you draw rapid quantity adjustments with no price adjustment?
Keynes’ Law of Markets Segment of Aggregate Supply Curve
Total Demand and Supply Quantities
D, y
Keynesian Aggregate Supply Curve- Step 2
Price Level
P
But what happens if the economy approaches the wall of full employment?
The Wall
Yf.e.
D, y
Full Employment Level of GDP
Keynesian Aggregate Supply Curve- Step 2
Price Level
P
But what happens if the economy approaches the wall of full employment?
And certain sectors begin to run out of raw materials, excess capacity,
and labor with critical skills?
The Wall
Yf.e.
D, y
Full Employment Level of GDP
Keynesian Aggregate Supply Curve- Step 2
Price Level
P
But what happens if the economy approaches the wall of full employment?
And certain sectors begin to run out of raw materials, excess capacity,
and labor with critical skills?
Will the businesses in those sectors be able to just increase the
amounts they produce?
The Wall
Yf.e.
D, y
Full Employment Level of GDP
Keynesian Aggregate Supply Curve- Step 2
Price Level
P
But what happens if the economy approaches the wall of full employment?
And certain sectors begin to run out of raw materials, excess capacity,
and labor with critical skills?
Will the businesses in those sectors be able to just increase the
amounts they produce?
The Wall
What will companies have to do if they’re faced with increased
orders from customers and their costs of raw materials and labor
are rising dramatically?
Yf.e.
D, y
Full Employment Level of GDP
Keynesian Aggregate Supply Curve- Step 2
Price Level
P
Faced with shortages of inputs and strong orders,
companies in critical sectors will be forced to
begin raising prices.
The Wall
Yf.e.
D, y
Full Employment Level of GDP
Keynesian Aggregate Supply Curve- Step 3
Aggregate Supply
Price Level
P
And if demand in the economy were to continue to rise,
other companies would face rising input costs, shortages
of raw materials and labor. They, too, would join in
and raise prices.
The Wall
Yf.e.
D, y
Full Employment Level of GDP
Keynesian Aggregate Supply Curve
S=( Aggregate Supply)
P
The Wall
Yf.e.
D, y (quantities)
Supply-Side Economics Aggregate Supply Curve
Price Level
P
What law of markets is behind Supply-Side Economics?
Aggregate Demand or Supply
D, y (quantities)
Supply-Side Economics Aggregate Supply Curve
Price Level
P
What law of markets is behind Supply-Side Economics?
According to Say’s Law of Markets, what will suppliers
adjust faster, quantities produced or prices?
Aggregate Demand or Supply
D, y (quantities)
Supply-Side Economics Aggregate Supply Curve
Price Level
P
If companies adjust prices much faster than the
quantities of stuff they produce, how do you draw
the aggregate supply curve?
Aggregate Demand or Supply
D, y (quantities)
Supply-Side Economics Aggregate Supply Curve
Price Level
P
S=Aggregate Supply
Say’s Law- prices adjust faster than quantities produced
Q’s
p
r
i
c
e
s
Aggregate Demand or Supply
D, y (quantities)
Supply-Side Economics Aggregate Supply Curve
Price Level
P
S=Aggregate Supply
Aggregate Demand or Supply
D, y (quantities)
Supply-Side Economics Aggregate Supply Curve
Price Level
P
S=Aggregate Supply
Aggregate Demand or Supply
D, y (quantities)
Keynesian or Supply-Side Aggregate Demand Curve
P
If prices are very high, will demanders be willing
and able to buy very much?
Quantities demanded
D, y
Keynesian or Supply-Side Aggregate Demand Curve
P
If prices are very high, will demanders be willing
and able to buy very much?
But if prices of stuff were to fall, everything else
equal, what will happen to demanders’ ability and
willingness to purchase stuff?
Quantities demanded
D, y
Keynesian or Supply-Side Aggregate Demand Curve
P
When prices
fall,
People will be willing
and able to buy larger
quantities of stuff
D= Aggregate Demand
Quantities demanded
D, y
Keynesian or Supply-Side Aggregate Demand Curve
P
D= Aggregate Demand
Quantities demanded
D, y
Why does one Keynesian demand curve rise and the other
one fall?
• Demand’s relation to Price
Level
• Demand’s relation to Y
D
D
P
D
Y
Hint: Note what is being placed on the axes.
D or y
Why does one Keynesian demand curve rise and the other fall?
• As income rises, people can
spend more
D
• As price level falls, people can
buy larger quantities of stuff.
D
D rises
P
As P
falls
As Y rises
Ability to buy
stuff rises
Y
D
D or y
Keynesian View of an Increase in Investment Spending
• What is the prime mover of the
macroeconomy according to Keynes?
Keynesian View of an Increase in Investment Spending
• What is the prime mover of the
macroeconomy according to Keynes?
• How will an increase in investment feed
through the economy from the Keynesian
perspective?
Keynesian View of an Increase in Investment Spending
• What is the prime mover of the
macroeconomy according to Keynes?
• How will an increase in investment feed
through the economy from the Keynesian
perspective?
• How do you show the effects on an
aggregate demand and supply diagram (with
P on the vertical axis and D & y on the
horizontal?)
Keynesian View of an Increase in Investment when
the economy is in a recession
S=( Aggregate Supply)
P
D before
Dafter I rises
The Wall
Pbefore=Pafter
Y before
Y after
Yf.e.
D, y (quantities)
Results: if I goes up during a recession, real GDP will rise without any inflation of Prices
Keynesian View of an Increase in Investment when
the economy is approaching full employment
S=( Aggregate Supply)
P
D before
The Wall
P2
P1
Dafter I rises
Y1
Y2
Yf.e.
D, y (quantities)
Results: if I goes up when the economy is near the wall, real GDP and Prices will rise
Supply-Side View of an Increase in Investment
• What is the prime mover of the
macroeconomy?
Supply-Side View of an Increase in Investment
• What is the prime mover of the
macroeconomy?
• How will investment in new equipment and
technology affect the supply capacity of the
economy?
Supply-Side View of an Increase in Investment
• What is the prime mover of the
macroeconomy?
• How will investment in new equipment and
technology affect the supply capacity of the
economy?
• Which way will the aggregate supply curve
shift?
• Show on an aggregate demand and supply
diagram
Supply-Side Economics : effects of an increase in Investment
S before
S after increase in I
P
P1
P2
D
y1
y2
D, y
Results: Investment creates more supply, and with the extra supply,
producers will adjust prices downwards so lower P and increased y
Keynesian Tax Policy During Inflationary Periods
• If an inflation is happening, what should the
Federal Government do to taxes?
• Show how this is supposed to work on a
Keynesian diagram (P on vertical, D or y on
horizontal axis)
Keynesian Tax Policy to Stop Inflation: Raise
taxes and Demand will be dampened.
S=( Aggregate Supply)
P
D after
The Wall
P1
P2
D before policy
Y2
Y1
Yf.e.
D, y (quantities)
Results: Demand decreasing policies can prevent inflation from taking hold
Supply-Side View of a Tax Increase
• How will a tax increase affect the supply
capacity of the economy?
Supply-Side View of a Tax Increase
• How will a tax increase affect the supply
capacity of the economy?
• What will happen to peoples’ desire to work
overtime if there is a high marginal tax on
the extra earnings?
Supply-Side View of a Tax Increase
• How will a tax increase affect the supply
capacity of the economy?
• What will happen to peoples’ desire to work
overtime if there is a high marginal tax on
the extra earnings?
• How will this affect the position of the
aggregate supply curve?
• What will happen to inflation, real GDP?
Supply-Side Economics : effects of an increase in taxes
S after
S before tax increase
P
P2
P1
D
y2
y1
D, y
Results: Tax Increases Reduce the Supply Capacity of the Economy,
thereby causing Prices to Rise and real y to fall. Stagflation
Supply-Side View of a Tax Increase
• How will a high profits tax affect the supply
capacity of the economy?
Supply-Side View of a Tax Increase
• How will a high profits tax affect the supply
capacity of the economy?
• What will happen to a company’s ability to
develop new technologies and invest in
productivity enhancing equipment?
Supply-Side View of a Tax Increase
• How will a high profits tax affect the supply
capacity of the economy?
• What will happen to a company’s ability to
develop new technologies and invest in
productivity enhancing equipment?
• How will this affect the position of the
aggregate supply curve?
• What will happen to inflation, real GDP?
Supply-Side Economics : effects of an increase in profits
taxes
S after
S before tax increase
P
P2
P1
D
y2
y1
D, y
Results: Tax Increases Reduce the Supply Capacity of the Economy,
thereby causing Prices to Rise and real y to fall. Stagflation
Supply-Side View of a Tax Increase
• How will a high tax rate on interest income affect
peoples’ desire to save?
Supply-Side View of a Tax Increase
• How will a high tax rate on interest income affect
peoples’ desire to save?
• What will happen to the total savings in the
country if there’s a high tax on savings?
Supply-Side View of a Tax Increase
• How will a high tax rate on interest income affect
peoples’ desire to save?
• What will happen to the total savings in the
country if there’s a high tax on savings?
• How will low savings affect interest rates?
Supply-Side View of a Tax Increase
• How will a high tax rate on interest income affect
peoples’ desire to save?
• What will happen to the total savings in the
country if there’s a high tax on savings?
• How will low savings affect interest rates?
• The ability of corporations to get funds to invest?
• How will this affect the position of the aggregate
supply curve? The macroeconomy?
Supply-Side Economics : effects of an increase in taxes on
savings
S after
S before tax increase
P
P2
P1
D
y2
y1
D, y
Results: Tax Increases Reduce the Supply Capacity of the Economy,
thereby causing Prices to Rise and real y to fall. Stagflation
What kinds of tax cuts are best from a Supply-Side View?
What kinds of tax cuts are best from a Supply-Side View?
• Taxes that increase total savings and
investment
What kinds of tax cuts are best from a Supply-Side View?
• Taxes that increase total savings and
investment
• Example 1: capital gains tax cut: this will
raise the income of the wealthy, and they
have a very high average propensity to save
What kinds of tax cuts are best from a Supply-Side View?
• Taxes that increase total savings and
investment
• Example 1: capital gains tax cut: this will
raise the income of the wealthy, and they
have a very high average propensity to save
• Example 2: corporate profits tax cut: this
will allow companies to plow more money
back into productivity enhancing activities
Supply-Side Economics : effects of a tax cut that increases
savings or investment
S before
S after increase in I
P
P1
P2
D
y1
y2
D, y
Results: Investment creates more supply, and with the extra supply,
producers will adjust prices downwards so lower P and increased y
Work out on your own:
• Compare a Keynesian and Supply-side view
of the macro-effects of an oil price increase.
Show on diagrams
• Which theory better explains the late 1990s
rapid economic growth, low unemployment
rates, and low inflation rates? Show on
diagrams