Question

What were the major areas of disagreement between John Maynard Keynes and the classical economists? Do you believe that either of these schools of thought are relevant in today's economy?

Answer 1

The main differences between the theory of John Meynard Keynes and classical theorists are:

1. There is always full employment in the economy : Classical theorists assumed that full employment (no involuntary employment) of labour and other resources always exists (based on Say’s law of markets). unemployment was an abnormal situation and economy adjusts itself back to full employment level if at all unemployment occurred in short-run whereas Keynes disregarded Say’s law of markets and showed that equilibrium level of national income and employment was determined by aggregate demand and aggregate supplyand it is due to the alck of aggregate demand , equilibrium level of income and employment is established at far less than full-employment level in a free market capitalist economy.

2.Only the Study of Allocation of Resources emphasized : As the existence of ‘full employment’ is assumed to be a normal situation according to classical , it implied that factors of production are always fully employed and there is no further scope for additional employment of resources in new industries. Factor of production could move from one industry to another , i.e., increase in production in one industry was thus achieved only at the cost of some decrease in another industry.

3. No Government intervention : classical assumed that the market is perfect and there is no need for government intervention and thus encouraged laissez-faire approach whereas according to Keynes markets are imperfect and thus not self-sustaining

4. Cut in wage as a Policy for Cure of Unemployed Resources : Classicals considered wage cuts through wage bargains between the workers and employers, therefore, wage-cuts will reduce unemployment as perfect competition always in the labour market.But Keynes pointed out that wage cuts could further aggrevate the problem of unemployment as cut in wage would reduce consumption expenditure which in turn would decrease aggregate demand.

5. Assumption of Neutral Money : Classicals regardes money only as a medium of exchange and did not consider its role as a store of value. They believed that money only facilitated the transactions of goods but had no effect on income, output and employment and only motive for holding money, was the transaction motive.Precautionary and speculative motives for holding money was not considered by classical whereas, Keynes specially mentioned about the store value of money and said that it has plays the role of precautionary and speculative motive and considered money on as on active force that in influences total output.

6. Interest Rate balances Saving and Investment : Classicals considered that it is the rate of interest that equalizes saving and investment at full employment of resources, it means that both saving and investment are highly sensitive to changes in the rate of interest.They believed that saving and investment could be equal only at full employment.

RELEVANCE OF KEYNESIAN AND CLASSICAL THEORIES IN TODAY'S ECONOMY

Keynes introduced the concept of AD and AS , sticky wages and multiplier effect of money.These Policies were influential in helping us get out of recession and they are still relevant today and can mostly be implemented during recession.

Keynes theory is inapplicable in under developed countries. According to Keynes, employment depends upon effective demand, which manifests itself in the spending of income. effective demand is low in underdeveloped countries, but it is due to low level of income and not on account of excess savings, as is the case in advanced economies.

Hence the theory of effective demand, as enunciated by Keynes, does not hold good in underdeveloped countries.

In many aspects classical theory too doesn’t apply. concept of lesseiz faire is totally outdated as government is expected to act to keep economy in equilibrium via its varios policies