Economics: Unit 3-Classical vs. Keynesian

Classical vs. Keynesian Debate

Modern Followers:

• Classical: Adam Smith
• Keynesian:
• John B. Say
• John Maynard Keynes
• Neo-Keynesians

Say's Law

• Classical:
• Supply creates its own demand
• Production equals income, which equals spending
• Under-spending is unlikely
• Keynesian: 
• Depression deputes Say's Law
• Demand creates its own supply
• Under-spending persists

Saving and Investment

• Classical:
• From Households to Business
• Invest = Savings
• Spending
• Keynesian:
• Savings does NOT equal investment (different motivations)
• Savings
• Future needs
• Precaution
• habit
• Income level
• Interest rate
• Investment
• Interest rate
• Rate of Profit
• Expectations

Lonable Market

• Classical

• Keynesian:
• Investment savings from cash, checking accounts
• Lending creates money, therefore money supply increases
• Inflation and Unemployment are unstable

Wage/Price Flexibility

• Classical 

• Keynesian:
• Inflexible downward
• Not very competitive

Output and Employment

• Classical: 
• Aggregate Supply determine output and employment
• Keynesian: 
• Aggregate Demand determine output and employment

Unemployment:

• Classical:
• Rarely exists due to price wage flexibility
• The causes are external like war or famine
• Keynesian:
• Usually exists
• Causes are external like war or famine
• Or internal where investment is not equal to savings

Aggregate Demand (AD)

• Classical:
• AD determines the price level
• AD is reasonably stable if the money supply is stable
• Keynesian:
• AD changes dues to the determinants (C, G, Ig, Xn)
• AD is unstable even if money supply is stable, due to fluctuation in spending

Basic Equation

• Classical: 
• MV = P (Price) * Q (Quantity)
• Used from 1965 to 1972
• Keynesian
• GDP = G + C + Ig + Xn
• Used from 1973 to the present

Role of the government

• Classical
• lassie fair 
• Economy is self regulated
• Keynesian
• Fiscal policy (tax and spend)
• Economy is not self regulated)

Inflation

• Classical: caused by to much money
• Keynesian: Caused by to much demand

How long is the short run?

• Classical: A very short time
• Keynesian: A very long time

Emphasis Today

• Classical: Microeconomics
• Keynesian: Macroeconomics