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    Macroeconomics Assignment 2

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    Vealmurugan Thirumalai
    This document summarizes the key differences between classical and Keynesian economic theories. Classical theory believes the economy is self-regulating through flexible prices and wages, while Keynesians argue government intervention is needed. Specifically, classical theory relies on Say's Law and assumes savings will be invested, while Keynesians believe savings depend on income rather than interest rates. Additionally, classical theory claims lowering wages leads to full employment, but Keynesians argue it reduces demand and employment. The document outlines these core disagreements between the two theoretical approaches.

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    Macroeconomics Assignment 2

    Uploaded by

    Vealmurugan Thirumalai
    46 views5 pages
    This document summarizes the key differences between classical and Keynesian economic theories. Classical theory believes the economy is self-regulating through flexible prices and wages, while Keynesians argue government intervention is needed. Specifically, classical theory relies on Say's Law and assumes savings will be invested, while Keynesians believe savings depend on income rather than interest rates. Additionally, classical theory claims lowering wages leads to full employment, but Keynesians argue it reduces demand and employment. The document outlines these core disagreements between the two theoretical approaches.

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    This document summarizes the key differences between classical and Keynesian economic theories. Classical theory believes the economy is self-regulating through flexible prices and wages, while Keynesians argue government intervention is needed. Specifically, classical theory relies on Say's Law and assumes savings will be invested, while Keynesians believe savings depend on income rather than interest rates. Additionally, classical theory claims lowering wages leads to full employment, but Keynesians argue it reduces demand and employment. The document outlines these core disagreements between the two theoretical approaches.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    46 views5 pages

    Macroeconomics Assignment 2

    Uploaded by

    Vealmurugan Thirumalai
    This document summarizes the key differences between classical and Keynesian economic theories. Classical theory believes the economy is self-regulating through flexible prices and wages, while Keynesians argue government intervention is needed. Specifically, classical theory relies on Say's Law and assumes savings will be invested, while Keynesians believe savings depend on income rather than interest rates. Additionally, classical theory claims lowering wages leads to full employment, but Keynesians argue it reduces demand and employment. The document outlines these core disagreements between the two theoretical approaches.

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    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 5

    Macroeconomics Assignment #2

    Jessica Rodrigues

    Mr. Gregory Renwick

    22nd February,2017.
    The Classical Economic theory is based solely on the concept of laissez faire concept

    of marketing. Laissez faire marketing, also known as free marketing involves an economy that

    has no government intervention. Classical theorists also believe that the economy is a mechanism

    that can fix itself without any intervention, in that the economy is self -regulating. They believe

    that the economy is capable of achieving its own natural level of real GDP. They validate this

    theory by two assumptions; supply creates its own demand ( Say’s Law), and that prices, wages

    and interest rates are flexible.

    As suggested by Say’s Law, an economy is able to generate a level of income that is

    necessary to purchase the amount of real GDP that it produces. This means that the economy is

    able to demand the level of output chosen to be produced by firms. Although the economy is able

    to generate enough income to purchase the same amount of real GDP, there is no guarantee that

    all income generated will be used for purchasing power, instead some of it will be saved. If not

    all income is spent on goods and services, then the aggregate demand for these goods and service

    will be less than aggregate supply. This will cause a cut back in production of the firms within

    the economy and therefore employment of the economy’s resources, and this will cause the level

    of real GDP to also fall below its natural level. The way in which the classical theorists validate

    their theory of the economy being able to fix itself without any intervention what so ever is this;

    they believe that at some point, the aggregate saving in the economy will at some point be used

    borrowing and aggregate investment, which in fact is a component of real GDP, which means

    that over time the level of real GDP will return to its natural level without any intervention.

    The second assumption of the classical theorists is that prices, wages and interest rates

    are flexible. In the case that aggregate saving in higher than aggregate investment. This means

    that interest rates will fall encouraging a higher demand by investors for the available funds,
    which will increase investment expenditure which will help to restore real GDP to its natural

    level also. The flexibility of the interest rate is a key component in the self-regulation of the

    economy, it helps to ensure the money market is always in equilibrium. Likewise, the flexibility

    of wages help keep the labour market in equilibrium. In the event the supply of workers for any

    firms exceeds the firms demand workers, the firm immediately responds by a reduction is wages

    paid to the workers. This ensures that the firms are always able to employ the full workforce, and

    no labour is left unemployed. According to the classical theorists, any unemployment within any

    market in economy, specifically the labour market is because of voluntary unemployment, in that

    the workers may refuse to accept the lower wages. But generally, all economies are seen to have

    potential for full employment.

    There was an opposing view to the Classical theory approach known as the Keynesian

    theory approach. The Keynesian theory completely disagreed with view of the economy being a

    self-regulating mechanism, the Keynesians thought government intervention was necessary for

    the real GDP to remain at its natural level. The Keynesians had two main opposing views of the

    Classical approach; the factors that determine the level of saving, interest rates and investment,

    and the properties of docking between wage levels with the use of labour by employers.

    The Keynesians believed that the amount of savings acquired by a household is determinant on

    the size of the household and its income. The greater the income received by the household, the

    more disposable income left after spending for saving. Therefore a household’s major

    determinant for saving depends on the size of income generated by the household. While on the

    other hand the Classical theory suggested that the level of interest rates would determine the

    level of saving. Although the Keynes theory still acknowledged like the Classical theory, that the

    level of interest rates do impact the decision made for investment, the Keynesians believed there
    are other factors involved that determine the investment expenditure. These factors include, the

    state of the economy, if the forecast for its future developments are high and how much applied

    technology is used within the economy. If all three are positive, even if interest rates are high,

    investors will still be drawn in, as the economy will foresee no sudden downfalls in the near

    future. Likewise, if the interest rates are low, and these factors are in the negative, investment

    will not be worth it as the economy will be suffering presently and in the near future.

    The Keynesians also had an opposing view to the flexibility of wages. They believed

    that the lowering of wages would not create full employment as the Classical theorists did, as

    they believed it will reduce spending power which will set of a trail of mishaps. Lower wages for

    employees, mean a lower purchasing power for households on goods and services. This will

    create a reduction in production capacity, which means finally there will be a reduction in the

    workforce for the economy. According to the Keynesians theory, this clearly means that a

    reduction in wages, will not create full employment, in fact it will decrease the employment in

    the economy.
    References

    The Classical Theory. (n.d.). Retrieved February 21, 2017, from

    https://www.cliffsnotes.com/study-guides/economics/classical-and-keynesian-theories-output-

    employment/the-classical-theory

    Criticism Of Keynesian Against Classical View Economics Essay. (n.d.). Retrieved February 21,

    2017, from https://www.ukessays.com/essays/economics/criticism-of-keynesian-against-

    classical-view-economics-essay.php

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