Mark Hardy 1

Classical vs Keynesian Economics

Classical and Keynesian economics are two different economic views we look at

today. Based on past uses of the Keynesian model, I think the American people should

look into a new economic system. However, I will get started with looking into the

classical side of things.

In the classical view it is said, supply creates its own demand. This means that

desired expenditures will equal actual expenditures. These, ideas are brought to us by a

known term, Says Law. With Says law, now have something called circular flow.

This circular flow, shows says law in action. People supply goods and services,

generating income, which means consumer demand for goods and services. Now lets

get into some of the assumptions made by classical economics.

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

interest, and people cannot be fooled by money illusion. These all seem like reasonable

assumptions. One key point in the classical view of economics is that, the government

doesnt have to get involved. This would explain why the (AS) aggregate supply curve is
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always vertical in classical economics.

The Keynesian view opposed the vertical AS curve. Keynes said there is a

(SRAS) short run aggregate supply curve and a (LRAS) long run aggregate supply

curve. I will explain more about the Keynesian view later. For now lets look into the

relationship between savings and investment.

It is believed that savings has would disrupt the idea of circular flow.

However, classical economists believed savings wouldnt be a problem due to business

investment. The equilibrium point at which the savings curve and investment curve

cross, shows us how much people save will be equivalent to the amount which

businesses invest. This equilibrium point also shows us the interest rate, which means

the amount of credit demanded equals the amount of credit supplied. The two graphs

shown, show us the relationship between savings and investment.

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One key part for classical economics is the relationship between unemployment

and real GDP. The graph for the labor market looks similar to the interest rate and

investment graph. The demand for labor is downward sloping which means a higher

wage means less workers will be hired. The supply curve for labor is upward sloping

which means at higher wages, more people will be looking for jobs. As you can see, a

wage set higher than the equilibrium point, will cause unemployment.

The relationship between real GDP and employment is, the hourly wage combined with

employment = real GDP. Says law also comes into play with employment.
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In classical theory it is impossible for an economy to deter from full employment,

due to the flexibility of interest rates, prices, and wages. This means the country always

tends to be at full employment. Full employment is represented by the LRAS curve.

Now lets get into the details of Keynesian economics. One of the most important

parts of Keynesian economics is how Keynes saw the behavior of the AS curve. Keynes

said the AS curve there is a LRAS curve and a SRAS curve. The reason the AS is

different is because Keynes said the prices are sticky, it takes time for the economy to

adjust to price changes. In the short run the AS curve is said to be horizontal.
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With the pieces of the Keynesian graph put together it looks like this.

In this particular graph it shows a shift in aggregate demand away from equilibrium,

causing an inflationary gap. A shift in the other direction would be called a recessionary

gap. The whole idea of Keynesian economics is that the government can stabilize the

economy in a recession, or in an economy with inflation.

The government tries to control the AD through policies, one being monetary

policy and the other being fiscal policy. Fiscal policy shifts the AD through Government

spending and taxes. Monetary policy shifts the AD by pumping money into the

economy, or by pulling money from the economy. Again, the goal for Keynesian

economics is to stabilize the economy. The goal for classical economics is to let the

market run itself.

It seems to me like classical economics is the better option for our country.

Keynesian economics seems like an idea where people think they can control the

market, when in reality, rather than making things better Keynes just makes things
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worse. I think one reason for this is, people act on their own self-interest. The

government has a bunch of money and power hungry politicians, they could care less

about the American people other than the fact they need them to buy their golden

underwear. Keynes economics gives power to people who do not have great

responsibility.