Candace Stewart

4/18/17
ECON2020-002
MWF 9:00-9:50 AM
E-portfolio essay

Classical Economics vs. Keynesian Economics

Economists are regularly concerned with the production, consumption, wealth

and overall well-being of the economy while dealing with scarcity. There have been

theories of how an economy can best prosper, thus introducing Classical economics

and Keynesian economics. The effectiveness between Classical and Keynesian

economics has been highly debated in the economics world. Classical economics focus

greatly on economic freedom, believing that there is no reason for the government to

intervene in the markets because the economy is self-adjusting, in the end. Keynesian

economics, on the other hand, argues that government intervention is necessary for an

economy to function properly, for aggregate demand is a heavy influence on economic

output, in the short-run.

Classical economics came about during and then after industrialization. This

economic model greatly concentrates on self-serving economic growth and freedom.

There are four leading theories that makes up the Classical model: there is existent

pure competition, wages and prices are flexible, people are motivated by self-interest,

and people cannot be fooled by money illusion, which is thinking of money in nominal

value rather than real. (Miller) This model of thinking dates back to the 1770s, and was

the first organized attempt to explain the determinants of the price and national levels of

real GDP, employment, consumption, saving, and investment. (Miller) Established by

Adam Smith, J.B. Say, David Ricardo, John Stuart Mill, Thomas Malthus, and A.C.

Pigou, the Classical model strongly resembles the ideas of the laissez-faire and free
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4/18/17
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E-portfolio essay

competition. Instead of having the government intervene in the function of the markets,

the Classical theory is that the people of the economy will allocate scarce resources in

order to meet business and individual needs. (Admin). For it is very true that people act

according to self-interest. Spending of the businesses and people in a society is the

most important role for economic growth. Economists then proceeded to argue that total

national supply creates its own national demand. (Miller) This led to what is now known

as Says law, which states that supply creates its own demand, therefore it follows that

desired expenditures would equal actual expenditures. (Miller)

By the 1930s, Europe and the United States started to enter a recession

that the Classical model could not decipher, thus the Keynesian model, developed by

John Maynard Keynes, commenced. (Miller) According to Keynesian economics,

economic growth is heavily influenced by both public and private spending. However,

this theory also states that the economy will still have activity and growth if public

spending and business investments ceased, for the private or government spending is

the most important role in the economy and can handle the loss. Keynes and his

followers argued that prices, especially the price of labor or wages, were indeed

inflexible and could not decline resulting from existent work unions and long-term

contracts between businesses and employees. (Miller) In general economic terms, this

would mean that the prices are sticky since the prices are resistant and are not

susceptible to change like the Classical model claims. Keynes and his supporters
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4/18/17
ECON2020-002
MWF 9:00-9:50 AM
E-portfolio essay

claimed that is economic growth starts to lack, the government should react by

stimulating demand, for consumer income is what results in economic activity and

growth. Keynes also stated that the main focus during a recession is to spend

excessively to raise the GDP, and then later when the economy is stable, deal with the

resulting debt. Which, the problem is solved in the short-run, but creates another

problem to deal with in the future.

The Classical model of economics had good views on solving long-term

economic problems and building an economy that focuses on the freedom of markets

and competition. However, a big assumption that this model insinuates is that the

economy is always at full employment, and when the economy enters a recession, there

is no need for help because the economy is fully self-correcting and the problem will

eventually fix itself. (Nash) Well, especially during the Great Depression, there was

widespread unemployment, which was a result of business failure. Still to this day, there

is a high level of unemployment, meaning that everyone who wants to work is not all

working or cannot find a job. Also, the Keynesian model of economics was developed at

the time when Europe and the United states was entering a recession, in attempt to

outline the problem to come up with a solution, since the Classical model could not fully

distinguish and solve the problem considering the recession. Thus, the Classical school

of thought was not correct stating that the economy is entirely a self-adjusting economy,

at least not at an instant and when it comes down to an event as in a recession, for
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4/18/17
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E-portfolio essay

people do not consume as much as what is needed to keep the economy flowing.

According to classical economists, low interest rates should result in more investment

spending and demand would stay the same. Though Keynes contradicts this theory,

stating that this way of thinking is what eventually led to the recession, which later

occurred during the Great Depression. Keynes stated that businesses invest based on

the intentions of making profits, thus if there were a decrease in consumption that

seemed to be long-term, businesses will question future sales and intentions of profits.

Therefore, these businesses will most likely not be investing, even though the low

interest rates result in low priced capital.

The Keynesian theory and model is the best guideline to follow in order to

address the slow economy, low workforce participation, and idle wages today. The

Keynesian model focuses on solving problems in the short-run in order to reach

success in the long-run. This model is the best to follow if the economy was to enter a

recession, the reason why this model was created in the first place. The Keynesian

model recognizes that the economy can sometimes be strong, but then suddenly weak

and vice versa. Even if in the beginning, an economy is balanced and everyone is

employed, a strong demand for goods and services can put the economy above the full

employment level. (Nash) Economists refer to this event as an expansion. When there

is weak demand for goods and services, the economy is placed below the full

employment level, and economists refer to this as a recession. (Nash) Keynes and his

supporters claimed that prices, especially prices of labor, are not as flexible as Classical
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E-portfolio essay

economists think. As it is known today, unions and business contracts make it almost

impossible to change the prices, and it is important to be aware of this.

The debate between Classical economics and Keynesian economics has been

long going, being examined by many different economists over the decades. Before the

recession that came about in the 1930s, the Classical model developed by Adam Smith

and other supportive economists was the school of thinking, focusing on a free

competitive market with no government interference, believing that the economy is

always at full employment and is better off since it is self-adjusting to peoples different

needs. However, when the Classical model could not support nor give an explanation

regarding the recession, John Maynard Keynes developed the new school of thought,

referred to as Keynesian economics, which evolved around the problems of the

recession and the Great Depression in order to explain the situation, thus solving it.

Keynesian economics claimed that the economy is actually not always in full

employment, and needs to involve government spending in order to function properly. In

todays world, Keynesian economics is still the best route to guide the economy.

Works Cited
Admin. "Difference Between Classical and Keynesian." Difference Between.com
(2012). Web.
http://www.differencebetween.com/difference-between-classical-and-vs-keynesian/

Miller, Roger LeRoy. Economics Today-The Macro View. New Jersey: Pearson
Education, Inc., 2014. Print.
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E-portfolio essay

Nash, Jon. "The Keynesian Model and the Classical Model of the Economy."
Study.com (n.d.). Web.
http://study.com/academy/lesson/the-keynesian-model-and-the-classical-model-of-
the-economy.html