Keynes and Classical Economics

Read this article for more information about these competing perspectives. This section contains four subsections: "Wages and Spending," "Excessive Saving and Interest Rates," "Active Fiscal Policy," and "Multiplier Effect". Focus your attention on the portions within the four subsections that emphasize the short-run. You may observe that the differences among the various subsections tend to deal with the underlying nature of change.

Overview


In John Maynard Keynes' theory, some micro-level actions of individuals and firms – if taken collectively – can lead to aggregate macroeconomic outcomes in which the economy operates below its potential output and growth. Such a situation had previously been referred to by classical economists as a general glut. Following in Say's Law, that supply creates its own demand, classical economists believed that a "general glut" would therefore be impossible. Keynes contended that a general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn. This would lead to unnecessarily high unemployment and losses of potential output.

Keynes asserted that unemployment can be readily cured through governmental deficit spending, and that inflation can be checked by means of government tax surpluses. In other words, he argued that government policies could be used to increase aggregate demand, thus increasing economic activity and reducing high unemployment and deflation.

The basic concept, used in his theory, is aggregate national income, which is defined as equal to the money value of the national output of goods and services during a given time period. It is also equal to the aggregate of income received by individuals during the period (including undistributed corporate profits). Keynes' macroeconomic theories were developed in the context of mass unemployment in 1920s Britain and in 1930s America.