Question

1. Compare and contrast The Classical and Keynesian Theories.

2. Keynesian Theory played an important role in The Great Depression. Discuss. Read the website http://www.huppi.com/kangaroo/Keynesianism.htm for more insight about The Great Depression.

Answer 1

1) Classicals assumed full employment of labor and other resources always prevailed in the economy. Based on this assumption they concentrated on the problem of determination of prices, output and resource employment. They believed any departure away from full employment, a free market economy would automatically work to restore equilibrium. They argued that invovulntary unemployment was not possible. Say's Law, that supply creates its own demand cleared that the problem of lack of demand do not arise. Based on this they formulated the aggregate supply curve being parallel to the y-axis at the full employment level of output.

Keynesian theory showed how equilibrium level of national income and employment was determined by aggregate demand and aggregate supply and further that due to lack of effective aggregate demand equilibrium level of income and employment might be established at far less than full employment level. This causes involuntary unemplyemnt of labor on one hand and excess capacity on another. They showed the importance of government intervention needed to solve market deficiency. This theory laid greater emphasis on aggregate demand. With aggregate supply remaining unchanged in the short run, it is the deficiency of aggregate demand that causes underemployment equilibrium with the appearance of involuntary unemployment. They made the aggregate supply curve parallel to the x-axis.