Question

1. Explain the role of prices in the Keynesian model. Discuss both the original (simple) model and the later model that allows prices changes to occur. Specifically, discuss the implications of this for the Keynesian view of the labor market.

2. “The Keynesian model is in disagreement with the classical model principally over what happens in the short run, not the long run.” Explain the nature of the comment and the underlying theoretical reasoning.

Answer 1

1)

Keynesian model does not accept the notion of flexible prices and wages, thus, Prices are rigid in short run. Prices do not change to restore equilibrium in economy if demand slips down.

Unemployment rate rises when prices are rigid in short run. But over the long run, prices are flexible, thus full employment can be restored over the long run, but same can not be achieved in short run without government interference.

2)

Keynesian supporters do not dispute long run outcomes of classical economists. But they do not agree with short run predictions. Keynesian do not agree with classical that short run prices are flexible enough to restore equilibrium without intervention by the government.

Keynesian believes that equilibrium can not be achieved without government intervention.