Question

With reference to the two schools of thought regarding policy making, establish whether markets or governments should manage the welfare of the citizens and the performance of an economy.

Answer 1

The first reference is from the classical school of thought that says that is the market and its demand and supply forces, that should manage the performance of economy and resulting welfare for its people. As per this school of thought, there is a least or no Interference required from the government and it is the self correcting mechanism that can push the economy towards the long run output level, natural rate of unemployment and achieve potential output. Here, wages are considered to be flexible. For example, if there is a recession and AD curve shifts to the left, then it makes people to be unemployed. These unemployed people get ready to work at lower wages. It reduces cost of operations and SRAS shifts to the right. It increases the output and LR equilibrium is achieved. It is the way, classical school of thought works.

The second reference is from Keynesian school of thought that says that government should intervene strongly to manage the economy and welfare of people. it says that people change their consumption and saving behavior and wages are sticky in nature. So, it is the government spending during recession that can stimulate the AD. It will make firms to create supply and in the process, new jobs are created. As a result, purchasing power increases and AD increases further. It makes AD to shift to the right and LR equilibrium is achieved. So, it is the government that plays an important role to manage the economy and help people get jobs. It is the way, Keynesian school of thought works.