Keynesian Economics and Classical Economics
Differences Between Keynesian Economics and Classical Economics
Economics thinking has evolved over time as economists develop new economic theories to fit the realities of a changing world. Monetary and fiscal policies change over time. And so does our understanding of those policies.
Some economists argue that policies that lower the unemployment rate tend to raise the rate of inflation. Others insist that only unexpected inflation can influence real GDP and employment. If the latter economists are right, does government always have to surprise the public in order to improve economic conditions?
In this essay, important differences among schools of macroeconomic thought are discussed. Most economists probably do not align themselves solely with any one theory of macroeconomics, choosing instead to incorporate pieces of various schools of thought. But the two approaches we discuss in this essay i.e. Keynesian and classical, have had enormous impact on economics thinking and policy.
Keynesian economics, named after the English economist John Maynard Keynes, dominated the economics profession from the 1940s through the 1960s. Some economists today refer to themselves as ‘‘new Keynesians.’’ The common thread that pervades Keynesian economics is an emphasis on the inflexibility of wages and prices. This leads many Keynesians to recommend an activist government macroeconomic policy aimed at achieving a satisfactory rate of economic growth.
Keynesian economics grew out of the Great Depression, when inflation was not a problem but output was falling. As a result, the Keynesian model of macroeconomic equilibrium assumes that prices are constant and that changes in aggregate expenditures determine equilibrium real GDP. In an aggregate demand and supply analysis, the simple Keynesian model looks like the graph shown at right. The aggregate supply (AS) curve is a horizontal line at a fixed level of prices, P1. Changes in aggregate demand, such as from AD1 to AD2, cause
Economics thinking has evolved over time as economists develop new economic theories to fit the realities of a changing world. Monetary and fiscal policies change over time. And so does our understanding of those policies.
Some economists argue that policies that lower the unemployment rate tend to raise the rate of inflation. Others insist that only unexpected inflation can influence real GDP and employment. If the latter economists are right, does government always have to surprise the public in order to improve economic conditions?
In this essay, important differences among schools of macroeconomic thought are discussed. Most economists probably do not align themselves solely with any one theory of macroeconomics, choosing instead to incorporate pieces of various schools of thought. But the two approaches we discuss in this essay i.e. Keynesian and classical, have had enormous impact on economics thinking and policy.
Keynesian economics, named after the English economist John Maynard Keynes, dominated the economics profession from the 1940s through the 1960s. Some economists today refer to themselves as ‘‘new Keynesians.’’ The common thread that pervades Keynesian economics is an emphasis on the inflexibility of wages and prices. This leads many Keynesians to recommend an activist government macroeconomic policy aimed at achieving a satisfactory rate of economic growth.
Keynesian economics grew out of the Great Depression, when inflation was not a problem but output was falling. As a result, the Keynesian model of macroeconomic equilibrium assumes that prices are constant and that changes in aggregate expenditures determine equilibrium real GDP. In an aggregate demand and supply analysis, the simple Keynesian model looks like the graph shown at right. The aggregate supply (AS) curve is a horizontal line at a fixed level of prices, P1. Changes in aggregate demand, such as from AD1 to AD2, cause