Keynesian and Classical economics

INTRODUCTION:

The general theory by Maynard Keynes states that the level of employment is determined by the marginal efficiency of capital, marginal propensity to consume and the real interest rates, he also the level of output and employment is determined by aggregate demand and that the aggregate demand can be increased through an increase in government expenditure.

Keynes therefore advocated for government intervention in steering the economy while the classical economist argued that the government should not interfere with the running of the economy, on unemployment according to Keynes theory this problem could be resolved by the use of government policies, the two theorists differ in the causes and the solutions of unemployment, to the classical economists unemployment is caused by excess supply which is caused by high wage rates, high wage rates means low demand and therefore this causes unemployment, therefore the Classical economist believe that the economy should be left to adjust itself until an equilibrium is reached at full employment.

Says law was developed by Jean Say who was a French businessman, according to this theory there cannot be demand without supply, according to this law a recession which is characterized by high unemployment is not caused by low demand or lack of money, however an increase in money supply will result to inflation. The Say’s law therefore clearly identifies the difference between the Keynes theory and classical economists in their explanation of the economy.

Classical Economists and Say’s law:

Classical economist supports Say’s law that supply causes demand and that there is never over supply, the Law states that people will supply things to the economy so that they can get money to buy other goods in the economy that are of the same value they have supplied. This is in line with the classical economists who argue that money does exist in an economy and that money will flow in the economy and this flow of money flows from the businesses to the people through paying jobs.

The classical economist states that the price level is changed by the level of money supply, also that the amount of supply will always be at full employment such that producers will not change the level of supply but will adjust the price levels to achieve the required demand level, therefore because supply creates its own demand then in the long run the economy will be at equilibrium and this means very low or no unemployment.

According to the Says law the classical economist therefore defined the model of the economy as follows P X Q = M X V, where P is the price level, Q is the quantity of goods sold, M is the money supply and V is the velocity of money flow. As the level of money supply increases assuming that the level of money supply is constant then the price or the quantity of goods sold will increase. If on the other hand the money supply increases and assuming that the velocity level remains constant then the price level or the quantity demanded will rise, therefore our outcome for the model means that an increase in money supply is inflationally and that an increase in the velocity of money flow will lead to economic development.

Keynes Theory and Say’s law:

Keynesians dismisses Says law as a false statement, he argues that supply and demand should be separately analyzed, on supply Keynesians says that supply generates income, people will then consume this income, the largest portion of income goes to consumption while the rest is saved, they analyzed the consumption levels of the income in terms of marginal propensity to consume which will rise as the level of income rises.

The Keynesian economist therefore considered the model of the economy as Y = C + I + (X-M) where Y is income, C is consumption, I is the investment X is exports and M is imports. The model is further analyzed as C = (a + b Y) where a is the autonomous income level, b is the marginal propensity to consume and Y is the income level.

Conclusion:

We can conclude that the Says law is the major difference between the Keynes theory and the classical economists, the classical economist support the Says law and also advocate for a free market economy while Keynes argues that the government can solve the problem of unemployment in an economy through an increase in spending to increase the aggregate demand that results to lower unemployment levels.

References:

Alan Coddington (2003) Keynesian Economics: The First Principles, Rout ledge publishers, US Alfred William (1991) The Classical Economists and Economic Policy, University of Michigan press, Michigan George Douglas (1967) Macro-economic Theory: A Mathematical Treatment, Macmillan publishers, US Steven Kate’s (2003) Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Edward Elgar Publishing, US John Fender (1981) Understanding Keynes: An Analysis of the General Theory, Wiley publishers, US