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A-Level Economics · Keynesian LRAS (spare capacity) diagram question

AD rises while the economy is on the FLAT range of the Keynesian LRAS. What happens?

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The answer

Real output rises with no rise in the price level, because idle labour and capital are brought back into use. Plenty of unemployed labour and capital, so firms hire and produce without bidding up factor prices: growth with no inflation. On the flat range there is large spare capacity — idle workers, idle factories. Firms meet the extra demand by bringing those resources back into use rather than by competing for scarce ones, so wages and factor prices do not get bid up. Real GDP rises with no demand-pull inflation. This is why Keynesians say fiscal stimulus in a recession has no inflationary side effect — and the multiplier makes the growth gain bigger still.

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