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Keynesian Economics vs. Classical Economics

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Keynesian Economics vs. Classical Economics

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  • December 2011
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In economics, there are two main theories: Keynesian economics and Classical economics. Each approach to economics has a different take on monetary policy, consumer behavior, and last but not least, government spending. Let us first look into classical economics. The basis of the Classical Theory of Economics is self-regulation. Supporters believe that the economy is able to maintain its-self and is always capable of achieving the natural level of real GDP. While circumstances do occasionally arise that effect the economy, causing it to fall above or below the natural GDP level, self-adjusting mechanisms are believed to exist. The belief that prices, wages, and interest rates are flexible and Say’s Law are two of the classical economists most firmly held beliefs. Say’s law basically states that the economy is always capable of demanding all of the output that its workers and firms choose to produce. Hence, government intervention is not needed. Generally, political liberals would side with Classical economics. Keynesian Theory rejects Say’s Law of self-regulation and suggests that the relationship between aggregate income and expenditure is key. Keynesian believers agree that government should step in and implement policies that will regulate the economy more efficiently. Typically political conservatives would agree with the Keynesian Theory. Were I a policy maker receiving conflicting advice, I would consider all aspects of the issue including equilibrium real GDP, employment, and prices.

Money is measured in different ways, mainly focusing on the liquidity, or how easily and quickly it can turn into a spendable form (Ayer & Colligne, Pg. 328). There are three main measurements; M1, M2 and M3. M1 represents the most liquid form of money and consists of the sum of currency and coins in the hands of the public, demand deposits, checkable deposits, and travelers checks. M2 is the sum of M1 plus the balances in savings deposits and balances deposited...