Unit III: Classical vs. Keynesian Debate

Classical vs. Keynesian Debate

Topic	Classical	Keynesian
Modern Followers	Adam Smith, J.B. Say, David Ricardo, Alfred Marshall	J.M. Keynes
Say’s Law	-Supply creates its own demand -Product=income=spending -Underspending is unlikely -Whatever output is produced, it will be demanded	-Depressions refute Say’s Law -Demand creates its own supply -Underspending persists
Savings and Investments	-Savings= investment income -Savings (leakage)= investment (injection)	-Savings does not equal investment Savings: futures needs, precaution, habit, income level, interest level, rate of profit expectation
Loanable Funds Market IG= Gross investment R= interest rate SM= Supply of money		-Investment from savings, cash, checking accounts -Lending create money, SM increase -Inflation and unemployment are unstable
Wage/price flexibility	Prices and wages are flexible downward	Prices are inflexible downward (ratchet effect)
Supply Curve	Vertical	Horizontal
Output and Employment	AS determines output and employment	AD determines output and employment
Unemployment S= savings I= investment	It rarely exists due to wage price flexibility; the cause is external (war).	It usually exists due external causes (wars) and internal causes savings does not equal investment.
Aggregate Demand (AD)	-AD determines price level -AD is reasonably stable if the money supply is stable	-AD changes to the determinants -AD is unstable due to the fluctuation in investment spending
Basic Equation	MV=PQ	C+Ig+G+Xn= GDP
Role of Government	-Monetary rule -Maintain steady money supply -Laissez-faire is best -Economy is self- regulating	-Fiscal policy is believed (tax and spend) -Believes in active government -Economy is not self-regulating
Inflation (Percent change in PL increase)	Caused by too much money	Caused by too much demand
How long the short run is	Short time	Very long time
Emphasis today	Microeconomics	Macroeconomics
Additional information	-Competition is good -Believes in invisible hand (government and economy regulates itself) -In the long run, economy balance at full employment -Economy is always close or at full employment -They support the trickle-down effect, helping the rich first	- Competition is flawed -AD is the key, not AS -Leaks and savings cause recession -  Ratchet effects and sticky wages blocks Say’s Law -In the long run, we are dead.