2. CLASSICAL ECONOMICS
Who
Adam smith,David Ricardo,Alfred Marshal
CENTRAL PRINCIPLE
The economy is best organised as a self-regulating
system of markets.
3. Classical economics
WAGES AND PRICES ARE FULLY FLEXIBLE in
order to clear markets rapidly.
ECONOMY OPERATES AT FULL EMPLOYMENT
MOST OF THE TIME. Classical Aggregate curve is
vertical
4. Classical economics
MINIMAL GOVT INTERVENTION reflecting
distrust of government and belief in its inefficiency.
UNEMPLOYMENT in the economy is either
Voluntary or due to some External Interference.
5. Keynesian Economics
Who
John Maynard Keynes
CENTRAL PRINCIPLE
The economy often operates at less than full
employment; market system does not self adjust.
6. Key differences between classical vs keynesian
IN THE CLASSICAL WORLD
Free market economies are always stable
Tending towards full employment & full production
equilibrium
Free fluctuating pricies in the three macro markets
(Goods, money, labor)
IN THE KEYNESIAN WORLD
Free market economies are unstable
Equilibrium but no reason for full employment/full
production
7. Keynesian Economics
1. MARKETS CLEAR ONLY SLOWLY, IF AT ALL
A) In a depression or recession, much Employment is
Involuntary.
2. ECONOMY OPERATES LESS OFTEN THAN FULL
EMPLOYMENT, since market don’t clear
3. GOVT INTERVENTION MAY BE DESIRABLE TO
STABILIZE THE BUSINESS CYCLE.
(Fiscal and monetary policies)
8. Keynesian Economics
Demand becomes much bigger driving force
Supply will adjust to demand
According to Keynes; Demand creates its own
supply”
9. Keynesian policy Implications
Under the classical system, government had no role
in management of the economy- “Laissez faire” do
nothing.
Under Keynes, Government must step into to correct
instability of the economy.
If the economy faces recessionary gap, govt must increase demand by
spending more; lowering taxes;lowering interest;
If the economy faces an inflationary gap, govt must reduce demand by
spending less; raise taxes; increase interest rate;
10. US Federal govt objectives for Economy
Full employment(1933 & by Law 1946)-Federal govt
took responsibility to ensure the economy functions
at full employment- no more than 5% unemployment
Economic growth(1950)-Fed Govt took
responsibility to ensure the economy grows at a
consistent and healthy rate-Real GDP at
approximately 4% year
Price stability (1970) Fed govt took responsibility to
ensure the economy has stable prices- CPI increase
at no more than 3% per year
11. Classical & Keynesian Economics
The economy can experience recessionary gaps or
inflationary gaps
No reason why economy must come to equilibrium
at full employment
Aggregate supply will always adjust to Aggregate
demand not vice versa
Govt has a role and responsibility as maximizing
entity to manage the economy