In the two graphs below, start with identical long-run equilibriums, with AS₁(P^e₁), ASn, and AD₁ all intersecting to give Y = Yn, P^e₁ = P₁. Label intersection as A.

Label each axis, the AS₁, AD₁ and ASn curves you draw, and label the equilibrium points on each axis.

In both cases show a decrease in AD to AD₂, and show the short run impact on Y and P and label these Y₂, P₂. What has happened to Y and P in the short-run, as a result of the increase in AD?

Keynesian: Y ____ and P _____ Neoclassical: Y ____ and P _____

Label the equilibrium point as B.

Keynesian Neoclassical

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Yn Yn

What do Keynesians say should be done to | What do Neoclassicals say should be done to restore long-run equilibrium with Y = Yn? | restore long-run equilibrium with Y = Yn? | | | | | Show this process in the graph above, with the | Show this process in the graph above, with the new long-run equilibrium labeled Y_K, P_K, and | new long-run equilibrium labeled Y_NC, P_NC, and show one or two more short-run equilibriums if | show one or two more short-run equilibriums if this is a multistep process. Label this point K. | this is a multistep process. Label this point NC. | How do Y_K and P_K compare to Y₁ and P₁ you | How do Y_NC and P_NC compare to Y₁ and P₁ you started with? | started with? |

Which of these two approaches do you think will most quickly restore Y = Yn? Why?

Which of these two approaches do you think performs best on the macroeconomic goals of keeping output at its maximum sustainable level and of maintaining stable prices? Why?