Unit 3 - Classical vs. Keynesian (2-24-16)

CLASSICAL vs. KEYNESIAN

Modern Followers:

Classical:

• Adam Smith
• J.B. Say
• David Ricardo
• Alfred Marshall

Keynesian:

• Jim Keynes

Say's Law:

Classical:

• supply creates its own demand
• production = income = spending
• under spending is UNLIKELY

Keynesian:

• depressions refute Say's law
• demand creates its own supply
• under spending PERSISTS

Savings and Investments:

Classical:

• savings (leakage)  = investment (injection) income

Keynesian:

• savings NOT = investment
• future needs (precaution, habit, income level, interest rate)
• interest rate (rate of profit, expectations)

Loanable Funds Market:

Classical:

Keynesian:

• investment from savings, cash, and checking accounts
• lending creates money = money supply increases
• inflation and unemployment are unstable

Wage/Price Flexibility:

Classical: prices and wages are flexible downward
Keynesian: prices and wages are inflexible downward (ratchet effect)

Supply Curve:

Classical: vertical
Keynesian: horizontal

Output and Employment:

Classical: AS determines output and employment
Keynesian: AD determines output and employment

Unemployment:

(S = Savings, I = Investment)
Classical:

• cause: external (war)
• rarely exists due to wage price flexibility

Keynesian:

• usually exists
• cause: external (war), internal (S not equal to I)

Aggregate Demand:

Classical:

• AD determines price level 
• AD is reasonably stable if money supply is stable

Keynesian:

• AD changes due to the determinants
• AD is unstable even if money supply is stable due to fluctuations in investments

Basic Equation:

Classical: (MV = PQ)
Keynesian: (C + Ig + G + Xn)

Role of Government:

Classical:

• monetary rule maintain a steady money supply
• believes laissez faire is best
• economy is self-regulated

Keynesian:

• fiscal policy
• active government
• economy is not self-regulated

Inflation:

Classical: caused by too much money
Keynesian: caused by too much demand

How long the short run is:

Classical: short time
Keynesian: very long time

Emphasis today:

Classical: Micro-eco
Keynesian: Macro-eco

Classical:

• competition is good
• believe in invisible hand
• in long run, economy will balance at full employment
• economy is always close to or at full employment
• believe in triple down effect.

Keynesian: 

• competition is flaud
• AD is key, not AS
• leaks and savings cause recessions 
• in long run, we're all dead
• believe sticky wages block say's law