Key Concepts and Summary

Key Concepts and Summary

Keynesian economics is based on two main ideas: (1) aggregate demand is more likely than aggregate supply to be the primary cause of a short-run economic event like a recession; (2) wages and prices can be sticky, and so, in an economic downturn, unemployment can result. The latter is an example of a macroeconomic externality. While surpluses cause prices to fall at the micro level, they do not necessarily at the macro level; instead the adjustment to a decrease in demand occurs only through decreased quantities. One reason why prices may be sticky is menu costs, the costs of changing prices. These include internal costs a business faces in changing prices in terms of labeling, recordkeeping, and accounting, and also the costs of communicating the price change to (possibly unhappy) customers. Keynesians also believe in the existence of the expenditure multiplier—the notion that a change in autonomous expenditure causes a more than proportionate change in GDP.

Glossary

coordination argument

downward wage and price flexibility requires perfect information about the level of lower compensation acceptable to other laborers and market participants

expenditure multiplier

Keynesian concept that asserts that a change in autonomous spending causes a more than proportionate change in real GDP

macroeconomic externality

occurs when what happens at the macro level is different from and inferior to what happens at the micro level; an example would be where upward sloping supply curves for firms become a flat aggregate supply curve, illustrating that the price level cannot fall to stimulate aggregate demand

menu costs

costs firms face in changing prices

sticky wages and prices

a situation where wages and prices do not fall in response to a decrease in demand, or do not rise in response to an increase in demand