Question

What are some key differences between Keynesians and Neo-classicists? What is Fiscal Policy? Who can make and control fiscal policies? How does fiscal policy impact AD? How can fiscal policy impact AS?

Answer 1

Difference between Keynesian and Neo-classicists;-

(a) Keynesian theory is based on governments' spending and aggregate demands in the marketplace while Neo- Classical theory is based on free market economy without any government intervention.

(b) Keynesia economists believe that government intervention in the market system can stabilize the economy while Neo-classical economists believe that the market will be in equilibrium till there is no intervention from the government.

(c) According to the Keynesians, there are frictions in the market where prices are inflexible as it does not fix quickly with the change in demand and supply. On the other hand, Neo-Classicals believe in free markets where prices change with the change in demand and supply.

(d) Keynesian economists believe in the spendings of government during the recession to expand the economic growth but Neo-Classical economists believe that government spending during economic crisis aggravate the condition by increasing its spending in the public sector and decreasing in the private sector.

Fiscal policy refers to the government spending and taxation in order to expand or contract the economic system of a nation. Government keeps adjusting its spending and tax rates by increasing or decreasing according to the economic situations.

Government of a country has the complete control on the fiscal policies and government is the sole maker of fiscal policies.

Fiscal policy impact the AD when there is changes in the government taxation and spending. As Aggregate Demand is the total demand of final goods and services in an economy in a given period of time, consumers spending and investment get influenced with the changing Fiscal policies. When government enacts expansionary fiscal policy during the time of recession, government spending goes up with cutting down the tax rates which increases the disposable incomes of households lading to the aggregate demand to increase and the economy expands. In contractionary fiscal policy, government reduces its spending and taxation goes up in order to fight inflation which reduces the disposable household incomes which results in the decrease in demands for goods and services causing the AD to decrease.

Fiscal policy has an indirect impact on aggregate supply which can be seen over a longer period of time. Aggregate Supply refers to the goods and services that firms intend to sell at a given period of time at a given price. When there is expansionary fiscal policy, tax rates are decreased which enable producers to maximise their profits by increasing production. The nature of taxation determines the the supply of goods and services in to an economy. The AS curve shifts to the right during the expansionary fiscal policy due to more opportunities for the producers to invest more in the market. The AS curve shifts to the left during the contractionary fiscal policy as tax rates go up which ultimately affect the production system due to less investments.