Keynesian Equilibrium and Output Gaps

Keynesian equilibrium occurs where aggregate demand (AD) intersects aggregate supply (AS), but this intersection may lie below full-employment output so that the economy can have spare capacity and higher unemployment. Keynesian analysis highlights wage and price rigidities and the negative multiplier as reasons a deflationary (recessionary) gap can persist, and it argues that fiscal or other demand‑boosting policies may be required to restore full employment. When plenty of spare capacity exists, increases in AD raise real output with little inflation, but as the economy nears full capacity further AD increases mainly push up the price level, creating an inflationary gap.