Question

Keynesian model vs Classical model

Explain why you agree with the Keynesian model. Give detailed reasons why you agree with three specific principles in the model. Focus on the ideas that are realistic, meaning you observe that the principle is true in real life.

Explain why you disagree with the Classical model. Give detailed reasons why you disagree with Choose three specific principles in the model that you disagree with. Give detailed reasons why you disagree with these three principles. Focus on the ideas that are not realistic.

Answer 1

Answer :

Keynes believed that government should manage consumer demand through policy and taxation, thereby avoiding inflation and unemployment, the results of too much and too little demand, respectively. Keynesian economics are in contrast to supply-side economics, an economic system that puts the onus on investors and entrepreneurs to grow the economy.

Reasons to agree with Keynesian Model :

Higher Employment Levels : Among the numerous pros and cons of Keynesian economics, one of the most prominent benefits is the higher employment levels supported by the economic model. In recessionary periods, employment drops off and unemployment rates soar as businesses cut back on the size of their workforce. Lack of employment then decreases consumer demand for products and services as families tighten their belt. Thus, a dangerous downward spiral is created. When the government steps in to financially stimulate businesses, those companies begin to hire once again. When the government invests in public works projects, they directly increase employment. With both methods, the downward spiral is halted.

Stabilization of the Banking Industry : As witnessed during the 2008 to 2009 recession, instability in the American economy led to banks and other lending institutions tightening up on lending. Without access to funding, small business start-up and growth halted, and the real estate industry suffered as mortgages were difficult to obtain. When the government steps in to guarantee loans, lenders are more confident in providing the capital needed in both the business and consumer markets. An argument against Keynesian economics, as discussed in Seeking Alpha, is that it's possible for the government to issue too much stimulus money and that this excessive amount of leverage can be destructive.

Tighter Control on Government Spending : While Keynesian theory allows for increased government spending during recessionary times, it also calls for government restraint in a rapidly growing economy. This prevents the increase in demand that spurs inflation. It also forces the government to cut deficits and save for the next down cycle in the economy.

Tools to Monitor Economic Output : One of Keynes' goals was to be able to monitor the total economic output of a country, an action that, at that time, had not yet been done in America or England. Keynes developed the precursor to the Gross National Product, in which the health of the economy can be measured by its production versus its capacity. By understanding and measuring these indicators, a government is better able to predict recessionary and inflationary cycles, and is thus better equipped to step in early to intervene in negative situations.

Moderation of Interest Rates : In an overly-stimulated economic cycle, the demand for loans to increase consumption and investment outstrips lenders' abilities to provide them. This causes increases in interest rates, fueling inflation. Under Keynesian theory, government spending in such a market is curtailed, lowering the overall demand for loans and cooling off interest rates and, ultimately, inflation.

Classical Economics :

• Classical economic theory was developed shortly after the birth of western capitalism. It refers to the dominant school of thought for economics in the 18th and 19th centuries.
• Classical economic theory helped countries to migrate from monarchic rule to capitalistic democracies with self-regulation.
• Adam Smith’s 1776 release of the Wealth of Nations highlights some of the most prominent developments in classical economics.
• Theories to explain value, price, supply, demand, and distribution, was the focus of classical economics.
• Classical economics was eventually replaced with more updated ideas, such as Keynesian economics, which called for more government intervention.

Criticism of Classical model :

The classical economics of Adam Smith had drastically evolved and changed by the 1880s and 1890s, but its core remained intact. By that time, the writings of German philosopher Karl Marx had emerged to challenge the policy prescriptions of the classical school. However, Marxian economics made very few lasting contributions to economic theory.

A more thorough challenge to classical theory emerged in the 1930s and 1940s through the writings of British mathematician John Maynard Keynes. Keynes was a student of Alfred Marshall and admirer of Thomas Malthus. Keynes thought that free-market economies tended toward underconsumption and underspending. He called this the crucial economic problem and used it to criticize high-interest rates and individual preferences for saving. Keynes also refuted Say's Law of Markets.

Keynesian economics advocated for a more controlling role for central governments in economic affairs, which made Keynes popular with British and American politicians. After the Great Depression and World War II, Keynesianism had replaced classical and neoclassical economics as the dominant intellectual paradigm among world governments.

Example : Adam Smith’s 1776 release of the Wealth of Nations highlights some of the most prominent developments in classical economics. His revelations centered around free trade and a concept called the "invisible hand" which served as the theory for the beginning stages of domestic and international supply and demand.  This theory, the dual and competing forces of demand-side and sell-side, moves the market to price and production equilibrium. Smith’s studies helped promote domestic trade and led to more efficient and rational pricing in the product markets based on supply and demand.