The basic idea behind Keynesian economics is that an economy needs some form of stimulation in order to increase aggregate demand. By looking into this possibility, economists try to determine what influences aggregate demand and, thus, the level of economy-wide output. The main goal here is to provide an explanation on why certain economic policies, such as increases in government spending or unemployment, have a significant impact on the level of economy-wide output. For the purpose of this article, we will be looking at two main forms of Keynesian economics.
Classical economics is different macroeconomic theories regarding how individual economic output is largely affected by aggregate demand. In the classical view, overall demand does not always equal the actual productive capacity of the economy as a whole. In fact, it is affected by a number of variables. These variables can either create surplus production or demand depression, depending on the size of the discrepancy between demand and supply. In this case, both the quantity of money and the level of total income are considered as important factors influencing the level of economy-wide output.
In contrast, Keynesian economics focuses more on the role of market demand in determining the level of overall output. In this form of analysis, demand, rather than the size of the money supply, becomes the key determinant of market demand. The idea behind this is that if people are able to purchase a large amount of goods quickly, there will be a significant rise in the supply of money. The idea behind this is that when the level of available money is high enough, there will be a strong incentive for people to invest in business activities. In this light, it can be concluded that the level of overall output in Keynesian vs. classical economic theories is primarily determined by changes in market demand.
Classical economics vs Keynesian economics are also related to how they think about the business cycle. Most modern monetarists, including many British classical monetarists, believe that the business cycle reflects the general state of the economy, which they believe ranges between being on a dynamic growth path, known as a pre stagflation condition, to being on a declining path, called a deflation condition. According to this view, the key factor in determining the state of the economy is the state of the business cycle, which they say describes how the state of the economy reacts to the changes in state of affairs surrounding it. In a classical monetary system, the government controls the supply of money and the level of bank reserves to ensure that the interest rates are kept stable. On the other hand, in a Keynesian perspective, money is a constraint on the ability of a firm to earn profits.
Another central concept in both theories is value. It was noted above that money plays a major role in society. To determine its value, according to Keynesian theory, the value of money depends on how a nation's total income is invested. On the other hand, according to monetarist theory, value is determined by how a firm or a country's total capacity to produce goods and services is judged by consumers. Thus, the value of money would be the value of commodities that consumers at that time could buy.
So, these are just some of the Keynesian concepts that are important to understand when studying both the Keynesian and monetarist school of thought. Both theories have their own merits and flaws, which are discussed below. The important thing is that both concepts can help one better understand the direction the economy is headed.
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