Macroeconomic Equilibrium: Classical vs. Keynesian Models

Key Concepts

• Macroeconomic Equilibrium: Occurs where Aggregate Demand (AD) equals Aggregate Supply (AS)

Classical Model

• Two Types of Equilibrium:
  1. Short Run Equilibrium (SRE): AD = Short Run Aggregate Supply (SRES) ≠ Long Run Aggregate Supply (LRAS)
  2. Long Run Equilibrium (LRE): AD = SRES = LRAS

Diagrams

• Short Run Equilibrium

  • When AD = SRES ≠ LRAS
  • Can indicate two types of gaps:
    • Deflationary/Recessionary/Negative Output Gap: Producing below full employment (YFE)
    • Inflationary/Positive Output Gap: Producing above YFE
  • Example Explanations
    • Deflationary Gap: Economy producing at Y1, but not at YFE
    • Inflationary Gap: Economy producing beyond YFE using unsustainable methods (e.g., overusing labor, running machinery 24/7)

• Long Run Equilibrium

  • Occurs when AD = SRES = LRAS
  • Economy is at Full Employment (YFE)
  • No gaps (inflationary or deflationary)

Keynesian Model

• Keynesian LRAS Curve: Can show long run equilibrium wherever AD intersects LRAS
  • Key Features:
    • Unlike classical models, equilibrium can occur at various points along the LRAS
    • Example Scenarios:
      • AD intersects LRAS at Y1 and P1, which may not be at YFE, but it's considered a long run equilibrium
      • Any intersection point along the LRAS (vertical or horizontal) can be a long run equilibrium
  • Simpler representation compared to classical model

Summary

• Classical and Keynesian models offer different interpretations for macroeconomic equilibrium
• Next video will cover shifts in these curves