Supply and Demand: Classical vs. Keynesian Economics

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Table of Contents

Introduction
Classical Theory on Supply and Demand
Keynesian Theory on Supply and Demand
Comparing and Contrasting Classical and Keynesian Models
Conclusion
References

Introduction

The Classical model was the most popular prior to the advent of the Great Depression that devastated the United States in 1930. The core idea behind the Classical view of the economy is that this model allows for a flexible adjustment of prices and wages over time (Kiat, 2018). Therefore, it could be deemed free-flowing, as all the economic challenges could be resolved with enough resources available to the parties involved in the issue. In a sense, the Classical model is a large swing that fluctuates in accordance with the good and the bad times, with wages and prices being altered accordingly (Bresser-Pereira, 2016; Trezzini & Palumbo, 2016). These upward and downward movements were considered normal because the adepts of the Classical model believed that all available resources should be used to their full capacity. At the same time, all eligible individuals were expected to contribute efforts to the country’s economy in order for the model to function as expected. Thus, the fluctuation was idealized to an extent where the Classical model became a textbook example of a self-adjusting economy that can survive any recession.

As for the Keynesian model, it appeared in response to the Great Depression of 1930 because the Classical approach did not seem to maintain its usual cost-benefit balance. Owing to the efforts of John Maynard Keynes, the new economic model was developed in order to step away from the past self-adjusting approaches and never utilize full employment capacity (Aspromourgos, 2019). These principles were proposed in an attempt to ensure that the economy’s potential is not wasted and that all employees and organizations have the room to go either below or above their inherent capability. Given the growing unemployment rates caused by the Great Depression, it was essential for economists to come up with strategies that would not leave businesses failing over and over again. With corporations trying to maintain the highest levels of performance while not having the resources to back up their ambition, Keynes was motivated to deploy a new economic model that would release the tension (Kiat, 2018). Accordingly, the Keynesian model revolved around the short-term corrections that would keep the economy alive.

Classical Theory on Supply and Demand

An essential argument that has to be mentioned when dwelling on the value of the Classical theory is that supply does not create demand. The reason why this statement has to be revised is that the fluctuations of demand are going to be caused by the saved income that is not consumed by businesses and the community in any way (Bresser-Pereira, 2016). Accordingly, there will be resources that are not invested anywhere, remaining in the possession of respective individuals and organizations. In turn, the reduction in demand will be caused by this unpredictable amount of savings that cannot be utilized to subsidize production. This scenario is going to cause a disproportionate scenario where most investors are going to hesitate when advancing, and the majority of savers will remain idle as well (Belongia & Ireland, 2021). The inequality between savings and investments would then cause the gap to grow and force the government to come into play, but the Classical theory revolves around the idea that government spending is not going to affect supply on a long-term scale.

Also, the Classical theory seemed to overlook the growth and decrease in population while not adjusting to the possible technological improvements. The focus on supply was rationalized by the need to keep worker income intact even if the wage rate had to be cut without prior notice, reducing the demand (Farnham, 2014). The inherent balance between investments and savings was achieved through the interface of modified interest rates. The authority that the monetary bodies had when mediating the rate of interest was enough to affect spending allocated by investors, but the overall influence of this agency was limited. The Classical model was most handicapped during the recession periods. The emphasis on reduction of the rates of emphasis brought the government back to increasing supply and ensuring that the business community would be able to survive the constant modifications (Farnham, 2014). Accordingly, the key stimulus to the Classical model was the imperative need for fiscal policies that would arbitrate balanced budgets for the government instead of an artificially inflated aggregate demand.

Keynesian Theory on Supply and Demand

The Keynesian theory was much more based on the need to cover the demand-related needs of the economy, so the majority of respective policies had to reject the Classical model in order to function properly. According to the basics of the Keynesian model, it was rather unreliable to capitalize on monetary controls when unemployment had to be cured as soon as possible (Kiat, 2018). The existing inflexibility of wages had to be removed from the economic equation to make it easier for the government to avoid wage cuts. According to the existing evidence, the opportunity to reduce employee payments would not reduce the unemployment rates anyway (Bresser-Pereira, 2016; Belongia & Ireland, 2021). Therefore, the rates of effective demand were marked as the benchmark value in order not to aggravate the issue further and protect employees from losing their jobs. A similar issue was also covered by the Keynesian model in the area of price cuts because it was a priority for the adepts of that theory to avoid outstanding debts by any means. Later, the Keynesian theory was also extended by the idea that unregulated laissez-faire had to be removed.

With these arguments at hand, the core idea behind the promotion of the Keynesian economic model was to ensure that the full utilization of resources would be removed from the governmental agenda. The emphasis on demand growth was exceptionally necessary because the country’s administration, unlike in the Classical approach, had to take an active part in shaping and improving the state of the economy (Aspromourgos, 2019). Even though some of the ideas included in the Keynesian theory could be perceived as overly radical, the revolutionary spirit it maintained actually resonated with contemporary economic analysts. As noted by Trezzini and Palumbo (2016), the replacement for the Classical economic model was largely prompted by conservatives. They hoped to get over the Great Depression and protect the capitalist system by focusing on the importance of the demand for the country’s economy. The virtues of the Keynesian model were somewhat hindered by the social unrest caused by the growing unemployment rates, which was never the case under the Classical economic model (Farnham, 2014). As soon as it was proposed to ditch the laissez-faire approach to the US economy, the significance of demand grew even further.

Comparing and Contrasting Classical and Keynesian Models

Even though the two presented theories are fundamentally different, they are not so alike when looking at them through the prism of economic impact. The fact that both the Classical and Keynesian models are cautious and comprehensive shows how difficult it could be to pick just one model to proclaim it immaculate. One definite conclusion that can be made right away regarding both these models is that the Classical and the Keynesian theories were implemented at the right place and at the right time (Farnham, 2014; Trezzini & Palumbo, 2016). For instance, the Classical model allowed economists to outline the core benefits of investing in long-run initiatives and ensuring the focus on supply was not going to cease. At the same time, the Classical model was a perfect example of an economy where employment and resource utilization were the only priorities addressed by the government (Bresser-Pereira, 2016). According to Aspromourgos (2019), the Keynesian model was different because it revolved around the process of guiding an economy out of a recession and ensuring that the existing unemployment rates were acceptable.

Another reason why the two models have to be compared is that their approaches to supply and demand were basically dictated by the contemporary socioeconomic environments. Therefore, the Classical and Keynesian models were expected to serve their intended purpose of capitalizing either on supply or demand at the right time (Belongia & Ireland, 2021). Owing to the inexistence of any kind of generalization, both theories have failed at the end of the day because they could not take on the new problems emerging seemingly out of nowhere. Around the 1970s, both the Classical and Keynesian models were replaced by the Real Business Cycle model, Supply Side Economics, and numerous other upcoming frameworks (Bresser-Pereira, 2016). Nevertheless, the two outdated approaches served as high-quality benchmarks for their new proxies owing to how comprehensive the original models were for their subsequent eras. It may be safe to say that the Keynesian model still turned out to be significantly stronger than its Classical counterpart because it focused on preserving resources and developing a short-term outlook instead of rushing through challenges and attempting to resolve them all simultaneously.

From a philosophical standpoint, the Classical model was better than its Keynesian counterpart because there was no requirement to maintain economic efficiency before the Great Depression. Accordingly, the focus on increased supply moved the economy forward and motivated employers to retain workers and perform at full capacity (Trezzini & Palumbo, 2016). The Keynesian model only resorted to short-term growth sprints in order to protect resources and accept the fact that a certain rate of unemployment could be maintained from time to time as well. Thus, the presence of alternatives is not always a good thing because legacy solutions could be working perfectly under the new conditions unless the latter brought drastic changes to the economic environment (Aspromourgos, 2019). The rationale behind the development of new economic models is contingent on the fact that the primary objective of any model is to serve human interests. Compared to the Classical model, the Keynesian theory cannot be considered as successful because it failed US economics during the next recession in the 1970s. The focus on demand turned out to be damaging because the country did not have enough workforce and monetary resources.

At the peak of its development and efficiency, the Keynesian model was required to help the government cope with more upcoming challenges. The fact that the inability to capitalize on demand forced the Keynesian theory to crumble down and lead to the deployment of new methods is an informative experience. The aggregate demand cannot be handled at the same time as the issues related to inflation and recession keep snowballing, as none of these represent a short-term problem (Belongia & Ireland, 2021; Farnham, 2014). Overall, there are two implications that can be included in the current discussion to reinforce the exceptional value of the Classical economic model. The first is that the Keynesian theory does not presuppose the upsurge in inflation that follows the recession improvements achieved through the interface of aggregate output intensifications (Trezzini & Palumbo, 2016). The second implication revolves around a contrarily opposite scenario where the lack of attention to demand is going to degenerate the recession and reduce the output. Consequently, it can be claimed that the only thoughtful benefit provided by the Keynesian model was the possibility of managing the aggregate demand.

Conclusion

With all their flaws and benefits, the two models developed on the verge of pressing economic challenges became perfect additions to respective socioeconomic environments. The need to focus on long-term growth caused the adepts of the Classical model to miss the importance of demand and its influence on the recession. When the Keynesian model was first deployed, it was suggested that the short-term objectives were much more important due to the inexistence of a pressing need to utilize all capabilities. The difference between these attitudes shapes the debate on the efficiency of economic strategies and makes it possible to assume that serious reconstructions are fundamental. Without overturning the classical traditions, it can be impossible to see if there is any actual difference in the theoretical and practical value advertised by the given economic model. The inconsistencies that were spotted by the followers of the Keynesian philosophy were also imperative because they delineated the challenges that could be met by technologically advanced societies on the way to getting out of the recession and inflation collapses.

It is impossible to claim that the different approaches to supply and demand have been either correct or incorrect because the Classical model and its Keynesian counterpart were intended to reflect nothing else but the contemporary socioeconomic environment. The possibility to analyze these two theories in isolation makes it safe to say that the Classical model ultimately has passed the test of time, as its inherent values turned out to be closer to the general outlooks on economics after the recession that took place throughout the 1970s. The most important transformations do not occur overnight, and the Classical model is living proof of that statement. The interest in short-term growth turned out to be ineffective because it praised demand but forgot to challenge the existing supply quality and quantity. In the face of an economic collapse, the best choice would be to side with the Classical economic model because increased supply would cause the unemployment rates to diminish. The focus on supply is a much more peaceful approach because it supports transformation that takes on the lessons from the past and integrates them into the existing economic framework.

References

Aspromourgos, T. (2019). What is supply-and-demand? The Marshallian cross versus classical economics. Review of Political Economy, 31(1), 26-41.

Belongia, M. T., & Ireland, P. N. (2021). A classical view of the business cycle. Journal of Money, Credit and Banking, 53(2-3), 333-366.

Bresser-Pereira, L. C. (2016). Reflecting on new developmentalism and classical developmentalism. Review of Keynesian Economics, 4(3), 331-352.

Farnham, P. G. (2014). Economics for managers. Pearson.

Kiat, W. (2018). Commanding heights: The battle for the world economy, episode 1 [Video].

Trezzini, A., & Palumbo, A. (2016). The theory of output in the modern classical approach: Main principles and controversial issues. Review of Keynesian Economics, 4(4), 503-522.

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