In explaining persistent unemployment and output

Solution

Keynesian economics focuses on the short-run. John Keynes argued that inadequate overall demand could lead to prolonged periods of high unemployment. An economy’s output of goods and services is the sum of four components: consumption, investment, government purchases, and net exports (the difference between what a country sells to and buys from foreign countries). Any increase in demand has to come from one of these four components. He argued that during economic downturns, a lack of investment and consumer confidence could lead to a self-perpetuating cycle of low demand and unemployment, a situation he believed required government intervention through fiscal and monetary policy to stimulate the economy and restore full employment.  ·        Money supply plays an indirect role but does not automatically stimulate activity.

• Aggregate supply is more relevant in the long run.
• Population growth affects long-term capacity, not short-run demand.
• Automatic adjustment contradicts Keynesian theory.