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Unit 4: Theories of Income, Output and Employment: Keynesian Theory
Self Assessment Notes
Fill in the blanks:
7. …………………curve is also referred to as price-output response curve.
8. Increase in demand for money leads to………..in rate of interest.
9. Increase in aggregate expenditure shifts AD curve to the………
10. Long run AS curve is………….
11. AS curve assumes that the resources are…………….
12. Equilibrium in the goods and money markets is reached at point where…………..
4.3 Classical vs. Keynesian Theory
The following are some of the basic comparisons for a Keynesian economics vs. Classical
economics study:
Keynes refuted Classical economics' claim that the Say's law holds. The strong form of the
Say's law stated that the "costs of output are always covered in the aggregate by the sale-
proceeds resulting from demand". Keynes argues that this can only hold true if the
individual savings exactly equal the aggregate investment.
While Classical economics believes in the theory of the invisible hand, where any
imperfections in the economy get corrected automatically, Keynesian economics rubbishes
the idea. Keynesian economics does not believe that price adjustments are possible easily
and so the self-correcting market mechanism based on flexible prices also obviously
doesn't. The Keynesian economists actually explain the determinants of saving,
consumption, investment and production differently than the classical economists.
Classical economists believe that the best monetary policy during is a crisis is no monetary
policy. The Keynesian theorists on the other hand, believe that Government intervention
in the form of monetary and fiscal policies is an absolute must to keep the economy
running smoothly.
Classical economists believed in the long run and aimed to provide long run solutions at
short run losses. Keynes was completely opposed to this, and believed that it is the short
run that should be targeted first.
Keynes thought of savings beyond planned investments as a problem, but Classicalists
didn't think so because they believed that interest rate changes would sort this surplus of
loanable funds and bring the economy back to an equilibrium. Keynes argued that interest
rates do not usually fall or rise perfectly in proportion to the demand and supply of
loanable funds. They are known to overshoot or undershoot at times as well.
Both Keynes and the Classical theorists however, believed as fact, that the future economic
expectations affect the economy. But while, Keynes argued for corrective Government
intervention, Classical theorists relied on people's selfish motives to sort the system out.
Self Assessment
State whether the following questions are true or false:
13. Keynesian theorists believed in 'no monetary policy' idea.
14. Classical theorists believed that short run should be targeted first.
15. Keynesian theorists didn't believe in the concept of invisible hand.
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