Keynesian AD–LRAS Diagram – Demand Management and Full Employment
A Keynesian aggregate demand and long-run aggregate supply (AD–LRAS) diagram showing how real GDP and the price level interact across different phases of the economy, including spare capacity and full employment.
ad
AD: Aggregate Demand, downward sloping due to the wealth, interest rate, and net export effects.
lras
LRAS: Keynesian Long-Run Aggregate Supply, horizontal when there's spare capacity, upward-sloping as resources are used up, and vertical at full employment.
pl
PL1: Price level at equilibrium where AD intersects LRAS.
y
Y1: Full employment level of output, where all resources are fully utilized.
In the Keynesian model, the LRAS curve is horizontal at low levels of output due to spare capacity, then upward-sloping as resources tighten, and vertical at full employment (Y1).
The AD curve slopes downward, reflecting the inverse relationship between price level and real GDP demanded.
At low levels of output, increases in AD lead to higher real GDP without inflationary pressure.
As the economy approaches Y1, increased AD results in higher prices as capacity is reached, causing inflation.
This model supports the use of demand-side policies, especially during recessions when the economy operates below full employment.
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