The Classical and Keynesian economists covered much of the same material althoug
ID: 1200369 • Letter: T
Question
The Classical and Keynesian economists covered much of the same material although they had different things to say about it. Lay out what each theory said about the following:
a) The competitiveness of markets
b) The flexibility of wages and prices
c) The relationship between savings and the relevant type of investment
d) The nature of the velocity of money
e) The relevant AS curve to use
f) The power of fiscal policy
g) The power of monetary policy
h) The appropriate role of the government
Explanation / Answer
a) Classical economists assumed markets to perfectly competitive while according to Keynesian economists markets were imperfectly competitive.
b) According to classical economists wages and prices are highly flexible but Keynesians were of the opinion that wages and prices are sticky to some extent.
c) The strong form of the Say's law stated that the "costs of output are always covered in the aggregate by the sale-proceeds resulting from demand". Keynes argues that this can only hold true if the individual savings exactly equal the aggregate investment.
d) The classical economists emphasized the transactions demand for money in terms of the velocity of circulation of money. This is because money acts as a medium of exchange and facilitates the exchange of goods and services.
MV = PT where M is the total quantity of money, V is its velocity of circulation, P is the price level, and T is the total amount of goods and services exchanged for money.
According to Keynes, the transactions demand for money relates to “the need of cash for the current transactions of personal and business exchange”.
e) The Classical view is that Long Run Aggregate Supply is inelastic (vertical AS curve).
The Keynesian Long Run Aggregate Supply curve is positively sloped.
f) Classical economics places little emphasis on the use of fiscal policy to manage aggregate demand.
Keynesian economics suggests governments need to use fiscal policy, especially in a recession.
g) Classical theory is the basis for Monetarism, which only concentrates on managing money supply, through monetary policy.
Keynesian theory argues that monetary policies will be responsible for inflation or deflation.
h) According to classical economists, economy should be allowed to run on its own, there should be no government intervention.
According to Keynesian economists, government should actively participate in the economic run.