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Theories of economics: classical economics verses Keynesian economics.
Classical and Keynesian economics are two different economic philosophies. The classical economists usually oppose government intervention and believe that the free market creates efficiency automatically (Greenwald et al, 1988). However, Keynesian economists are in favour of general intervention by the state to create an efficient market (Blinder, 2007). Looking at price, demand and investment shows that although both classical and Keynesian economics agree in basic tenants of capitalism, Keynesian economics encourage greater government control.
The first assumption of classical economics is that the prices of everything are flexible for example, commodities, labour and land. Price flexibility means that markets are able to adjust themselves, and the prices fluctuate efficiently to equilibrium. Moreover, the market price fixes automatically without government intervention though the force of market demand and supply (Patil, 2012).
Says law is one of the fundamental principles of classical economics, which states “Supply creates its own demand” (Kates, 2005). It suggests that aggregate production of goods or services in an economy must generate exactly enough income to purchase all output. In addition, Says law states that the market ensures waiting buyers will purchase all goods produced. In reality today, this assumption does not hold because production is based on demand.
The last assumption of classical economics is that household savings equal the capital investment expenditures (Pavelescu, 2009). The potential problem is that, not all income generated by production is spent by household consumption. For example, if $100 is total income of a household; the household may spend $90 and save $10. As a result, supply does not create its own demand, because supply falls $10 short of creating enough...
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