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    Classical and Keynesian economists disagree on the best approach to economic modeling. Classical economists believe markets self-regulate without intervention, while Keynesians believe government intervention is needed. The Great Depression challenged the classical view that prices adjust, as prices and wages did not change much. Keynesianism rose to prominence but could not explain stagflation in the 1970s. Most economists now see classical theory as describing the long run but Keynesian theory as more accurate in the short run, as prices and wages are sticky initially. Adverse supply shocks can cause both inflation and recession.

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    lecture notes on trade

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    Classical and Keynesian economists disagree on the best approach to economic modeling. Classical economists believe markets self-regulate without intervention, while Keynesians believe government intervention is needed. The Great Depression challenged the classical view that prices adjust, as prices and wages did not change much. Keynesianism rose to prominence but could not explain stagflation in the 1970s. Most economists now see classical theory as describing the long run but Keynesian theory as more accurate in the short run, as prices and wages are sticky initially. Adverse supply shocks can cause both inflation and recession.

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    11 views14 pages

    Classical: Keynesian

    Uploaded by

    henry
    Classical and Keynesian economists disagree on the best approach to economic modeling. Classical economists believe markets self-regulate without intervention, while Keynesians believe government intervention is needed. The Great Depression challenged the classical view that prices adjust, as prices and wages did not change much. Keynesianism rose to prominence but could not explain stagflation in the 1970s. Most economists now see classical theory as describing the long run but Keynesian theory as more accurate in the short run, as prices and wages are sticky initially. Adverse supply shocks can cause both inflation and recession.

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    © All Rights Reserved
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    of 14

    Classical vs.

    Keynesian Economists
    Which model best describes our economy?
    Keynesian vs. Classical Approach

    Stock Market suddenly falls 25%

    LRAS1
    What Now?
    Price SRAS1
    Level
    Tax Cuts?
    Gov’t Spending?
    P1 --------------- E1 New Incentives?
    P2 --------- E2 Self-Regulation?
    --------

    AD1
    AD2

    Y2 Y1
    Real
    GDP
    Economy is at Full Employment when AS turns Vertical

    AS
    Price
    Level
    Classical Range

    Intermediate Range

    Keynesian Range

    AD

    Real GDP
    Economic Schools of Thought
    Classical Economics Keynesian Economics NeoClassical Economics
    |----------------------------| |----------------------------| |--------------------------------|

    1900 1929 1936 1979 1980 2008


    Keynesian Economics
    did not help here!

    Great
    Depression?
    Prices were
    not flexible!
    What Now?
    CLASSICAL VIEW
    1. Markets are naturally self regulating
    2. No government intervention necessary
    3. Recessions are temporary
    4. Wages & prices are flexible
    5. against minimum wages, welfare, government assistance
    6. Real Variables do not depend on nominal variables
    7. Great Depression challenged Classical View
    9-2b

    Classical View

    FIGURE 9-1
    Aggregate Supply and Aggregate Demand in Classical Economics
    Classical Model Failure: The Great Depression

    Real GDP ↓ 27%


    Price LRAS1
    Level
    Unemployment 3% → 25%

    Price Levels fell


    AD1
    AD2

    Real
    GDP However,
    Wages did not adjust
    KEYNSIAN VIEW
    1. Economy is inherently unstable
    • not self regulating
    2. Recessions can be long & permanent
    3. Major government intervention necessary
    4. Wages and prices are sticky/fixed
    • AS curve is very flat or upward sloping
    5. Support welfare and government assistance
    6. Stagflation challenged Keynesian view
    Keynesian Failure: “Oil Shock”
    1. An adverse shift in the SRAS
    Shifting AD
    Price would make
    Level inflation worse!
    LRAS
    SRAS2
    SRAS1

    B
    P2
    A
    P
    3. . . . and
    Price level ↑
    .
    AD

    0 Y2 Y Quantity of
    2. . . . causes R-GDP to fall . . . Output
    Reconciling 2-Views
    • Most economists believe classical theory describes world in
    the long run but not short run

    • Prices, Wages & interest rates are at least somewhat sticky in


    the short run

    • Keynesian economics focuses on AD and failed to explain the


    Stagflation of the late 1970’s
    Adverse Shifts in SRAS
    • Consider an adverse shift in short run aggregate supply:
    • curve shifts to the left
    • Output falls below natural rate of employment
    • BOTH unemployment & price level rise
    Stagflation
    • A period of recession and inflation.
    – Output falls and price level rises
    – Example: late 1970’s in USA (oil crisis)

    • Challenge: Policymakers who can influence aggregate


    demand cannot offset both simultaneously
    Classical Recovery
    2. . . . causes output to fall in the short run . . .
    Price
    Level

    LRAS
    SRAS

    SRAS2
    3. . . . but over
    time, the short-run
    P A aggregate-supply
    curve shifts . . .
    P2 B
    1. A decrease in
    aggregate demand . . .
    P3 C

    AD1
    AD2
    0 Y2 Y Quantity of
    4. . . . and output returns Output
    to its natural rate.
    Alphabet Recovery Part 2
    • http://www.pbs.org/newshour/bb/business/
    july-dec11/makingsense_10-07.html

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