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Keynesian economics | Aggregate demand and aggregate supply | Macroeconomics | Khan Academy - YouTube
Channel: Khan Academy
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Voiceover: What I want to do in this video
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is start introducing and
we've already talked about him
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a little bit.
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So actually they've
already been introduced,
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but maybe flesh out a little
bit more Keynesian thinking.
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This right here is a picture
of John Maynard Keynes
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and I often mispronounce him as Keynes,
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because that's how it's spelled,
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but it's John Maynard Keynes.
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He was an economist who did a lot
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of his most famous work
during the Great Depression,
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because in his view,
classical models did not seem
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to be of much use during
the Great Depression.
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To understand this a little bit better,
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let's compare purely
classical aggregate supply
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aggregate demand models to maybe one
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that's more Keynesian.
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Some of what we've talked about -
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Keynesian, I should say.
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I already did my first mispronunciation.
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One that's a little bit more Keynesian.
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Keynesian right over here.
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In some of the conversations,
we've already begun
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to introduce a little bit
of Keynesian thinking,
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but in this video we're going to try
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to show the difference between the two
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and it's not to say that one
is right or one is wrong.
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In fact, Keynesian felt
that in the long run,
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the classical model actually made sense,
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but he also famously said,
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"In the long run we are all dead."
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I also want to emphasize
that this isn't a defense
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of Keynesian economics.
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There are some points
to what he has to say,
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but there are other schools of thought.
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Unfortunately, they
often get very dogmatic,
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but they also have some reasons to be wary
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of Keynesian economics
and we hope to go over
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some of that in future videos.
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In this one, we just want to understand
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what Keynesian economics is all about
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and how it really was
a fundamental departure
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from classical economics.
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In classical economics, I'm going to use
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aggregate demand and
aggregate supply in both.
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This is classical, this is
price, this right over here
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is real GDP and I'm going to do it
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for the Keynesian case, as well.
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This is price and this
right over here is real GDP.
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In both views of reality, or both models,
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you have a downward sloping
aggregate demand curve
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for all the reasons
that we've talked about
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in multiple videos.
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That's aggregate demand right over there.
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We've already seen it,
the classical view is that
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in the long run, an
economy's productivity,
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or productive capacity,
or its output shouldn't
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be dependent on prices.
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We've seen the long run
aggregate supply curve
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something like this.
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This is the aggregate
supply in the long run,
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or sometimes you'll have
long run aggregate supply.
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Sometimes it'll be referred to that.
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Saying, look, all prices
are, they're a way to signal
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what people want and demand
and things like that,
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but at the end of the
day, prices and money,
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they're just facilitating transactions.
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You go to work and you
get paid and all that,
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but then you go and use
that money to go and buy
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other things that the economy produces,
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like food and shelter and transportation.
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All money is is a way of
facilitating the transactions,
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but the economy, in theory,
based on how many people
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it has, what kind of technology it has,
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what kind of factories it has,
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what kind of natural resources
it has, it's just going
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to produce what it's going to produce.
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If you were to just
change aggregate demand,
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if the government were to print money
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and aggregate demand were to -
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and just distribute it from helicopters,
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in this classical model,
you would just have
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aggregate demand shift to
the right, but you have
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this vertical long run
aggregate supply curve
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so the net effect is it
didn't change the output
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in this classical model.
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All that happens is that the price goes
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from this equilibrium price
to this equilibrium price
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over here.
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You have the price would go up
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and you would just experience inflation
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with no increased output
and there's multiple ways
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you could've shifted that
aggregate demand curve
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to the right.
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You could have a fiscal
policy where the government,
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maybe it holds its tax revenue constant,
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but it increases spending, or it goes
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the other way around.
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It does not decrease, it
doesn't change its spending,
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but it lowers tax revenue.
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Either of those, it tries to
pump money into the economy
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and pushes that aggregate
demand curve to the right.
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In this purely classical
view, it says in the long run,
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that's not going to be any good,
just will lead to inflation.
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The only way that you
can increase the output
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of economy is by making
it more productive.
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Maybe making some
investments in technology,
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make the economy more efficient,
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maybe your population grows.
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The only way is to really
shift this curve to the right
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on the supply side right over here.
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Keynes did not disagree with
that, but he sitting here
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in the middle of the
Great Depression, saying,
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"Look, all of a sudden
people are poor in the 1930s.
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"Factories did not get blown
up, people didn't disappear.
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"In fact, there are
factories that want to run,
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but they are being shut
down, because no one
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"is demanding goods from them.
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"There are people who
want to work, but no one
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"is asking them to work.
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"They could work and produce
wealth that could then
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"be distributed to -
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"But no one's demanding
for them to do it."
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He suspected something weird was happening
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with aggregate demand,
especially in the short run.
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In a very pure, very,
very short run model,
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I know we have talked about a short run
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aggregate supply curve
that is upward sloping.
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Something that might
look something like that.
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That is actually starting to put some
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of the Keynesian ideas into practice.
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What I like to think of
is something in between,
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but if you think in the
very, very, very short term,
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Keynes would say prices are
going to be very sticky.
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Especially in the short
run, and I'll call it
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the very short run, you have,
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especially if the economy's
producing well below
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its capacity, like it seemed to be doing
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during the Great Depression,
prices are sticky.
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That makes intuitive sense.
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If the economy's trying to get overheated,
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people are being overworked, you want them
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to work more, hey, I want overtime.
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You want factories to operate
faster, people are going
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to start -
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The utilization is high, people
are going to start charging
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more and more, but if I'm
unemployed and I'm desperate
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to work, I'm not going
to ask for a pay raise.
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If my factory is at 30%
utilization and someone wants
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to buy a little bit more, that's
not the time that I'm going
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to say, "Hey, I'm going
to raise prices on you."
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I'll say, "Yeah, exact same price.
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"You want another 5% of
my factory to be utilized?
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"Sure, that sounds great."
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In the very short run,
it has the opposite view
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of the aggregate supply curve
than the classical model.
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It says at any level of
GDP in the short run,
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prices won't be affected.
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It won't be affected.
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So in this model right over
here, this is aggregate supply
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I'll call it, in the very short run.
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You can debate what short
run or very short run means,
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whether we're talking
about days, weeks, months,
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or even a few years here,
but once you start looking
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at the world this way,
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then something interesting happens.
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In this model right over
here, the only way to increase
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GDP was on the supply side.
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In this model right over
here, the only way to increase
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GDP is on the demand
side, to actually either
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through monetary policy, print more money,
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or through fiscal policy, lower taxes
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while holding spending
constant or maybe do both,
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essentially deficit spending.
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Someway, without holding taxes constant,
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but the government's
spending more, whatever.
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Shift the curve to the right
and that might be a way
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to increase the overall output.
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Keynes' real realization was that, look,
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the classical economist
would tell you if you have
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a free and unfettered market,
the economy will just get
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to its natural, very efficient state.
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Keynes says, "Yes, that is sometimes true,
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"but that's sometimes not true."
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We'll talk about different cases.
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By no means do I think the Keynesian model
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is the ideal and I don't think even Keynes
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would have thought the Keynesian model
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describes everything.
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Depends on the circumstance.
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Keynes would say, "Look, let's think
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"of a very simple idea."
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You have person A, person
B, person C, and person D.
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Let's say person A sells
to person B, person B sells
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to person C, person C sells to person D,
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and person D sells to person A.
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Let's say that they're
all selling two units
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of whatever good and
service that they offer.
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For whatever reason, let's
say C, all of a sudden,
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just got a little bit
pessimistic, had a bad dream,
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woke up on the wrong
side of the bed and says,
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"You know what?
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"I'm not feeling so
good about the economy.
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"I'm going to hold off
from my purchase from B.
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Instead of two units, I'm
going to purchase one unit.
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Well, B says, "Well,
gee, my business is bad.
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"Now I'm only going to purchase one unit."
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A does the same thing for the same reason,
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D does the same thing.
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Now it all came back to C and now C says,
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"Wow, I was right, that
dream was predictive."
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It was a self-fulfilling prophecy.
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Now they're going to operate in this state
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and there might not be any
natural way to get them
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bumped up to that state
where they're all buying
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two units from each other
without maybe some outside,
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especially some government act
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or maybe all of a sudden saying,
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"Hey B, if C doesn't want
to buy two, I'm going
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"to buy two temporarily."
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There are dangers to this, huge dangers,
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and we'll talk about
that in future videos,
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but then someone else,
let's say the government,
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tries to shift the aggregate demand curve
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through fiscal policy and they say,
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"Hey, I'll buy one from you, B."
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Then B says, "Okay, now
I can buy two again,"
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and A can buy two again and
then D can buy two again
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and then C can buy two again.
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Then in an ideal world,
and this is the danger
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of the government, the
government would step back
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and say, "Okay, everything is fine again.
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"I don't have to buy this."
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As we know, it's very
hard once the government
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starts spending money in
some way, to actually cut
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this spending right over here.
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This was the general
idea behind the Keynesian
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versus the classical.
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He says, "Look, there are circumstances,
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"like the Great Depression,
where the economy
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"is operating well below its potential
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"and in those circumstances,
you need to have
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"a stimulus on the demand
side, not just a supply side."
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The correct answer, as with all things,
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is probably something in between.
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A probably more accurate
model is something like this.
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Let's draw ...
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This is price, this is
real GDP right over here
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and we'll still draw our downward sloping
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aggregate demand curve and
the more accurate thing
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might look something like this.
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Let's say that this is the absolute
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theoretical maximum output,
if everyone in the country
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isn't sleeping, the
factories are just being run
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to the ground, that's the
absolute theoretical output.
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Let's say that this is its potential.
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Just a healthy state where the economy
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might be operating.
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The real medium run
supply curve or short run
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aggregate supply curve.
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This is aggregate supply
in the very long run.
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This is the long run aggregate supply.
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The best model would be
something that's in between
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and might look something like this.
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Our aggregate supply curve
might look something like -
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I want to do it in a different color.
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Let me do it in magenta.
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It might look something like this.
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For whatever reason, maybe
someone has a bad dream
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or a bunch of people have a bad dream
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or something scary
happens, aggregate demand -
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The stock market crashes,
something happens,
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aggregate demand shifts over there.
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When we're out here, now all of a sudden
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our output is well below
potential, we have a lot
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of excess capacity and now
the Keynesian ideas seem
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maybe they'll make sense.
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Maybe there should be
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some outside stimulus happening.
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On the other side, if we're
performing well at potential,
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then all of a sudden the
government wants to do
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Keynesian policies and
we'll see in future videos,
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the government will always want
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to do Keynesian policies,
even if they're not justified.
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It will push aggregate demand out here
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and then the net effect is,
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especially the more
vertical this is, the more
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this net effect will be true,
that you really just get
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more inflation and you
don't really get a lot
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of increase in output.
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It really depends on the circumstance,
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but an aggregate supply
curve that starts flat
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at low levels of output
and then gets higher
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and higher slope and
becomes almost vertical
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in your high levels of
output, this is probably
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a better model that
takes into consideration
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both the classical and
the Keynesian ideas.
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