Question

1. Compare the Keynesian school to the classical school.   What are the implications to the issues discussed in a public finance course?

Answer 1

On demand efficient unemployment classical economists are of the view that unemployment is caused by factors in the supply side such as structural factors and frictional unemployment while the Keynesian theory states that unemployment is caused by insufficient economic growth.

On the flexibility of prices and wages, the classical theory is of the view that wages and prices are flexible while the Keynesian theory suggests that wages are inflexible.

On government borrowing, the classical theory suggests that governments should reduce borrowing while the Keynesian theory suggests that government borrowing should not be limited

Explanation:

KEYNESIAN VERSUS CLASSICAL ECONOMIC THEORY

The Keynesian economic theory was developed by British economist John Keynes as a response to the great depression of 1930.The classical economic theory on the other hand emerged after the emergence of Western capitalism and it was the most prominent economic theory in the 18th and 19th centuries. The two schools of thought have different points of view as discussed below.

For instance, on demand efficient unemployment classical economists are of the view that unemployment is caused by factors in the supply side such as structural factors and frictional unemployment. The Keynesian theory on the other hand states that unemployment is caused by insufficient economic growth and low aggregate demand growth rate.

On the flexibility of prices and wages, the classical theory is of the view that wages and prices are flexible and thus a reduction in wages should result in full employment. On the other hand, the Keynesian theory suggests that wages are not flexible and thus a reduction in wages would lead to a reduction in the aggregate demand of employment due to lower spending.

On government spending, the classical theory suggests that governments should be less involved in the management of the economy while the Keynesian theory suggests that there should be greater levels of government intervention in the economy especially during a recession.

On fiscal policy, the classical theory is of the view that fiscal policy does not do much in managing the aggregate demand. It suggests that instead, monetary policies should be used. The Keynesian theory suggests that governments should implement and utilize fiscal policies especially during a recession.

On government borrowing, the classical theory suggests that governments should reduce borrowing while the Keynesian theory suggests that government borrowing should not be limited since it helps increase the aggregate demand.

The two theories have implications on public finance in that policy makers have to take into account the views of the two schools of thought when making finance decisions. For instance, if a government is planning on borrowing they can take a look at the classical view which limits borrowing and the reasons why it limits borrowing. They can also look at the Keynesian theory which promotes borrowing and the reasons why it promotes borrowing. From there, the government can then go ahead and make a decision based on the analysis of the two theories.