Output Gaps and Keynesian Aggregate Supply

The second page delves deeper into output gaps, focusing on the Keynesian perspective of aggregate supply and its relationship to unemployment.

The diagram on this page illustrates a situation where the equilibrium level of national income (Y') is below the full employment level (YFE). This scenario represents a negative output gap, which is associated with cyclical unemployment.

Definition: Cyclical unemployment occurs when there is insufficient aggregate demand in the economy to provide jobs for everyone who wants to work.

Highlight: A negative output gap is closely linked to cyclical unemployment, as the economy is operating below its full potential.

The Keynesian aggregate supply curve is shown as relatively flat in the short run, indicating that changes in aggregate demand can have significant effects on output and employment without causing substantial changes in the price level.

Example: In a recession, a negative output gap may lead to layoffs in various industries as businesses reduce production due to decreased demand.

The diagram also shows multiple aggregate demand curves (AD1, AD2, AD3), illustrating how shifts in aggregate demand can affect the equilibrium level of output and potentially close or widen the output gap.

Understanding the relationship between output gaps, unemployment, and aggregate supply is crucial for policymakers when designing strategies to combat economic downturns and promote sustainable growth.

Vocabulary: Potential GDP (or potential output) is the maximum sustainable output an economy can produce when all resources are fully and efficiently employed.

This page emphasizes the importance of considering both the supply and demand sides of the economy when analyzing output gaps and their effects on employment and economic performance.