Question

Explain, with aid of diagrams, the effects of an expansionary fiscal policy under the classical theory and the Keynesian model. Compare and contrast the effects under the two models. How would these differences affect their conclusion on the role of government? (20%)

Answer 1

*answer:

Fiscal policy under classical theory

Fiscal policy under keynesian model

Defination of Fiscal policy under classical model

The classical view of expansionary or contractionary fiscal policies is that such policies are unnecessary because there are market mechanisms for example, the flexible adjustment of prices and wages which serve to keep the economy at or near the natural level of real GDP at all times.

Defination of Fiscal policy under keynesian model

Keynesian economics was developed by the British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression. Keynes advocated for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression.A

Keynesian economics is based on two main ideas. First, aggregate demand is more likely than aggregate supply to be the primary cause of a short-run economic event like a recession. Second, wages and prices can be sticky, and so, in an economic downturn, unemployment can result.

Differences between fiscal policy if classical theory and keynesian model

Classical economics places little emphasis on the use of fiscal policy to manage aggregate demand. Classical theory is the basis for Monetarism, which only concentrates on managing the money supply, through monetary policy. Keynesian economics suggests governments need to use fiscal policy, especially in a recession

There are certain points to be discussed along with that

a )Classical economics emphasises the fact that free markets lead to an efficient outcome and are self-regulating.

b) In macroeconomics, classical economics assumes the long run aggregate supply curve is inelastic; therefore any deviation from full employment will only be temporary.

c) The Classical model stresses the importance of limiting government intervention and striving to keep markets free of potential barriers to their efficient operation.

d) Keynesians argue that the economy can be below full capacity for a considerable time due to imperfect markets.

e) Keynesians place a greater role for expansionary fiscal policy (government intervention) to overcome recession.

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