Question

Compare and contrast the Classical Macroeconomic Model with the Keynesian Macroeconomic Model.

a. When was the Classical Macroeconomic Model Developed?

b. Why was the Classical Macroeconomic Model Developed?

c. Can the Classical Model explain economic fluctuations why or why not?

d. Can fiscal policy increase real economic output in the Classical Model why or why not?

e. Can monetary policy increase real economic output in the Classical Model why or why not?

f. What assumptions does the Classical Model make to arrive at this result for the impact of monetary policy?

g. When was the Keynesian Macroeconomic Model developed and why was it developed during this period?

h. What was the Keynesian Macroeconomic Model Trying to explain?

i.Can fiscal policy increase real economic output in the Keynesian Model why or why not?

j. Can monetary policy increase real economic output in the Keynesian Model why or why not?

Answer 1

A) the classical macroeconomic model was developed in the 19th century.

B) the classical macroeconomic model was developed to Showed that economy is self correcting which means that when a recession occured economy needs no help from anyone.

C) no classical model cannot explain fluctuation because of assumption of economy is self correcting.

D) no fiscal policy does not increase output in the classical model because there is full employment in tha labour market.

E) no monetory policy does not increase output in the classical model because no extra labour is available to produce more output.

F) The classical model beleives in the quantity theory of money, which is stated as , where P is price level, Y is real output, M is money supply and V is velocity of money. It is to be noted that PY will be the nominal GDP. The classical assumes that while V is constant over time, and economy is always at full-employment, an increase in M would not increase Y, but would increase only P, in the same proportion. Hence, according to the classicals, the increase/decrease in money supply would only affect Pm, resulting in inflation/deflation. The other supporting assumption to this are that wages are fully flexible in both directions (they can increase or decrease as well), and rejection of Phillip's curve even in the short run. This is the reason that classicals stressed that the economy should be laissez faire, and that government intervention during recession would only affect P, and not Y.

I) The fiscal policy does affects the real output in the Keynesian model, but to some extent. According to them, an expansionary fiscal policy would increase the real GDP when the economy is away from the full employment.

The change in AD1 to AD2 to AD3 to AD4 is caused by the government spending. The AS is the long run AS. The output in AD1 and AS is less than the potential output. As AD shifts, the output increases, but it is no use to increase it further than the AD4, as that would increase only price and not the real GDP. Expansionary fiscal policy would only affect the output untill the economy reaches its potential GDP, which is equal to the vertiacal portion of the AS (which is aka the classical portion of AS).

J) Keynesians argue that monetary policy doesn't directly affect the Y, but it does indirectly. Keynesian model states that change in money supply results to changes in loanable funds market, which causes changes in interest rate, and that causes change in Y. If there is an increase in money supply, then the interest rate decreases, and that increases the investment expenditure, increasing the Y. However, they don't emphasize it due to assumptions on the interest rate sensitivity of the economy for lower interest rate.