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Classics vs Keynes

by: savills

Classics vs Keynes Econ101


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Classics vs Keynes model
Principles of Macroeconomics
Dr. Kristen Kling
Study Guide
50 ?




Popular in Principles of Macroeconomics

Popular in Macro Economics

This 2 page Study Guide was uploaded by savills on Thursday September 22, 2016. The Study Guide belongs to Econ101 at Arizona State University taught by Dr. Kristen Kling in Fall 2016. Since its upload, it has received 76 views. For similar materials see Principles of Macroeconomics in Macro Economics at Arizona State University.


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Date Created: 09/22/16
Question on Classics versus Keynes Suggested Outlines The Classical model and Keynesian model are not the same. The wages are flexible in the Classical model while the Keynesian model assumes wages to be rigid downwards. The Classical Model During recession, consumers and firms cut down their expenses and workers are being retrenched. This causes AD   to sh0ft to AD . Price an1 output decrease. This causes unemployment to rise and output to fall (P  to P 0 and 1  to Y )0 P <P 1with1nom0nal wage W  0nchanged but real wage increases (W /P ). S >0D c1usesL nempL yment to happen. The classical economists believed that this unemployment will lead to a pay­cut. At a lower wage (a lower cost of production), firms are willing to produce more (SRAS [W ] 0 shift to SRAS [W ]). *herefore, the Classical model is a market clearing model and there is no sustained long­term unemployment. The wage is adjustable, because the workers want to keep their jobs and hence are willing to take the pay­cut.  The Keynesian Model 1 During recession, AD  wil0 shift to AD . This1cause P  to drop0to P  and outpu1 also decrease from Y  t0 Y . F1rms cut costs or close down. But in this model, labour refuses to take a pay­cut. This causes unemployment to prevail in the long­run. Hence, Keynesian model is a non­market clearing model.  Hence the main difference between the two models rest on the assumption of whether wages are flexible or rigid downwards. According to the Classicists, there was no empirical evidence to support the claim that money wages were rigid downwards and if they made the same assumption, their model would be the same as the Keynesians. In this respect, the statement is correct. As for whether the economy can be self regulatory, the Keynesians argued that even if money wages fell in the face of economy wide unemployment, real wages would not fall or fall far enough for aggregate demand to be stimulated. So if AD was not stimulated, there would be no permanent move to full employment and hence the economy would not correct itself. 2


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