Draw and properly label an AD-AS model to show Keynesian, intermediate, and neoclassical zones. Then, briefly explain the levels of unemployment, inflation, and real GDP in each zone, and confirm whether or not goals of a macro economy are being achieved in each zone.
The Correct Answer and Explanation is :
Here is the AD-AS model with the Keynesian, Intermediate, and Neoclassical zones labeled:
Explanation of the AD-AS Model Zones:
- Keynesian Zone:
- Characteristics: Located at the far left of the AS curve where it is relatively flat. This zone reflects conditions of high unemployment and unused capacity.
- Unemployment: High, as not all available resources are being utilized.
- Inflation: Low, due to the excess capacity and competitive pressures keeping prices down.
- Real GDP: Lower than potential, indicating that the economy is not operating at full efficiency.
- Macro Goals Achievement: Not fully achieved, as high unemployment suggests economic resources are not fully utilized.
- Intermediate Zone:
- Characteristics: The middle part of the AS curve where it begins to slope upwards. This zone reflects a tightening in the economy with increasing utilization of resources.
- Unemployment: Begins to decrease as more resources are employed.
- Inflation: Starts to rise as demand pressures increase and resources become scarcer.
- Real GDP: Approaching potential GDP, reflecting better utilization of resources.
- Macro Goals Achievement: Closer to achievement, but challenges in balancing rising inflation with decreasing unemployment.
- Neoclassical Zone:
- Characteristics: Located at the far right of the AS curve where it is steep. This zone is where the economy is at or near full employment.
- Unemployment: Very low, close to natural rate of unemployment, indicating nearly all available resources are utilized.
- Inflation: High, as economic output is at its maximum sustainable level and any increase in demand leads primarily to price increases rather than output increases.
- Real GDP: At or near potential GDP, representing an economy operating at full capacity.
- Macro Goals Achievement: Generally achieved in terms of employment and output, but may be challenged by high inflation.
This model helps in understanding how different levels of demand impact unemployment, inflation, and GDP across different economic conditions. Each zone represents varying challenges and trade-offs for policymakers aiming to stabilize the economy and promote growth.