Classical Economics vs. Keynesian Economics

My research of Classical Economics and Keynesian Economics has given me the opportunity to form an opinion on this greatly debated topic in economics. After researching this topic in great lengths, I have determined the Keynesian Economics far exceeds greatness for America compared to that of Classical Economics. I will begin my paper by first addressing my understanding of both economic theories, I will then compare and contrast both theories, and end my paper with my opinions on why I believe Keynesian Economics is what is best for America.
Classical Economics is a theory that suggests by leaving the free market alone without human intervention; equilibrium will be obtained. This theory was the first school of thought for economists and one of the major theorists and founders of Classical Economics was Adam Smith. Smith stated, “By pursuing his own interest, he (man) frequently promotes that (good) of the society more effectually than when he really intends to promote it. I (Adam Smith) have never known much good done by those who affected to trade for the public good.”(Patil) Classical Economic theory assumes three basic ideas: Flexible Prices, Shay’s Law, and Savings-Investment equality. Flexible prices in Classical theory suggests prices will rise and fall as needed but is not always true, due to, the interference of government agencies including unions and laws. Smith stated in the Wealth of the Nation (1776), “Civil government, so far it is instituted for the security of property, is in reality instituted for the defense of the rich against the poor, or of those who have some property against those who have none at all.” (Patil) Shay’s Law implies supply creates its own demand and demand is not based on production or supply.
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The last assumption is that savings will equal the investment which will lead to equilibrium; however, Classical theorist are realist and know this will not always happen, thus, they believe the flexible interest rates will help with the equilibrium.
Keynesian Economics was developed and founding by John Maynard Keynes. He believed and wrote in his book “The General Theory of Employment, Interest and Money” that it is essential for the Government to play a vital role in economic stability. Keynesian theorist believe Government spending, tax hikes or tax breaks are vital in economic success. Keynesian assumptions include: Rigid or Inflexible Prices, Effective Demand, and Savings-Investment Determinants. Rigid or Inflexible Prices suggest that wages increases are easier to take while wage decreases hits resistance; likewise, a producer will increase prices yet when needed will be reluctant to decrease prices. Effective Demand implies that only a portion of the household income will be used for consumption, leading the Keynesians theorist to believe that the effective demand can only be derived from the actual disposable income. Lastly, the Keynesian theorists believe savings and investments are based on one’s desire to save for the future and the expected profitability of the endeavor.
As stated above one can see there are great differences in Classical and Keynesian Economics. Classical Economic theorists believe the Government should have no role in the free market while Keynesians believe the Government is vital in maintaining equilibrium in the free market. Classical Economic theorists believe supply creates its own demand while Keynesians believe demand can only be derived from the actual disposable income. Another contrast between these two theories include: Classical Economic theorist believe flexible interest rates will help with the equilibrium of savings and investments, while, Keynesians believe equilibrium
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of savings and investments can only be obtained with the will of the savor and the expected profitability of the endeavor. In “Economics in Crisis: Severe and Logical Contradictions of Classical, Keynesian, and Popular Trade Models” written by Ravi Batra it is reported that Classical Economics almost died until inflation became intolerable and the Keynesian Economics made an error causing the Classical Economics to easily be brought into the economy. (p.623-624)
This research has brought new light for me in how economics/politics is played in America. Looking at recent events with the American Government, I now have a better understanding of how and why economics is so important. Hearing the word deregulation throughout the 2008 Presidential election, I never quite understood what it meant; I now am gaining a better understanding. I believed in the Keynesian theory before I even knew it existed and now I can say I feel stronger about the Keynesian Economics and I recognize the importance of this kind of economics for America. In “The Relevance of Keynes”, Robert Skidelsky states, “the classical
theory of the self-regulating market rested on the epistemological claim that market participants have perfect information about future events. Grant this and the full employment assumption follows, deny it and it collapses. Keynes’ economy, on the other hand, is one in which our knowledge of the future is usually very slight and often negligible and expectations are frequently subject to disappointment.” (p. 3) I agree with this because even in my short life I have seen many natural things change the economy such as September 11th or the Tsunami in Japan. No one can predict the future and everyone must be prepared for the worse. The websites and articles I found were intriguing in that they mainly disagreed with the Keynesian Economic theory. McCoach even went as far as to use scare tactics including a quote from Adolf Hitler,
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“Gold is not necessary. I have no interest in gold. We will build a solid state, without an ounce of gold behind it. Anyone who sells above the set prices, let him be marched off to a concentration camp. That’s the bastion of money” and later comparing Keynes and Hitler as having the same economics in the same sentence. (McCoach)
In “The Transition from the Classical to the Keynesian Perspective” written by Hukukane Nikaido, I found many different graphs which I have came to conclude is very important in an economic study. I found it hard to really understand the graphs but what I did gain from this article is that Keynesian Economics will continue because the graphs showed a great gain in Economic growth. I have further gained a greater appreciation for Keynesian theory for in this article Nikaido reports, “Keynes’s philosophy of the economic world should not be thought to be
confined to a depression economics. Moreover, it should be deeply impressed on our mind that this discordance applies in the short-run, but also in the long-run, contrariwise to the prevailing view of almost all economists. For a long-run analysis to ignore short-run aspects would be very fictional to the real economic world.” (542-543) My hope is America never has another economic catastrophe as we did in 1930’s and nearly again in 2000’s.



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