First, looking at the Classical economics theory, it is based largely on the thought that free markets can adjust themselves if left alone. Adam Smith, the founder of the Classical economics school of thought and author of 'The Wealth of Nations, ' states his thoughts as "there being an invisible hand (and automatic mechanism) that moves markets towards a natural equilibrium, without the requirement of any intervention at all" (Nikaido). He believes that eventually the free market will lean toward equilibrium. The main fault with Classical Economics is that Smith did not consider the greediness of humanity.
Within classical economics, there are three basic assumptions; one, flexible prices, two Say’s Law, and three savings-investment equality. First, flexible prices, states that the prices of everything: supplies, labor, land, etc., would need to equally increase and decrease based on the economy. Taking a look at wages specifically, we know that our society is on top of it when it comes to raising wages, but very cautious when it comes to lowering. Looking at Say 's Law, ‘supply creates its own demand’. “The Say 's law suggests that the aggregate production of an economy must generate an income enough to purchase all of the economy 's output" (Kates). Essentially, generating supply would cause its own demand; but our nation works the opposite by first looking at demand and then supplying it. Finally, savings-investment equality is the assumption that requires the household savings to equal capital investment. Making Classical Economics much like Communism, it looks great in writing, but when it comes to implementation, there are some major issues.
The second type of primary school of thought is Keynesian economics. "Keynesian economics is solely based on a simple logic, that there is no divine entity, nor some invisible hand, that can tide over economic difficulties, and we must all do so ourselves" (Nikaido). Keynesian economics believes that the Government is necessary in guaranteeing growth and economic strength. They rely on the government to smooth out all the little issues and business cycle bumps and pays more attention to government spending, tax breaks, and hikes. This is the most effective way for an economy to function.
Similar to Classical economics, Keynesian economics has three basic assumptions; one, rigid or inflexible prices, two, effective demand, and three, savings and investment elements. First, Rigid or inflexible prices are prices that are not as flexible as the people would like them to be. A few explanations why are long term wage agreements and long term supplier contracts. The main reason for the inflexible prices, it’s realistic to humanity’s view. The prices will increase without difficulty, but are extremely unwilling to decline. Second, Keynesian economics pressures the importance of effective demand while Classical economics stress the importance of supply. Actual demand is based on the real household disposable income versus disposable income that could be gained at full employment. Lastly, savings and investment determinants challenge savings-investment part of Classical economics. "They believe that household savings and investments are based on disposable incomes and the desire to save for the future and commercial capital investments are solely based on the expected profitability of the endeavor" (Widmaier).
Classical and Keynesian economics differ in many ways; however, there is one main difference that stands above the rest. Classical economics strongly believes in the free market can regulate itself and produce equilibrium; whereas, Keynesian has faith in the government to get involved and must be done 'ourselves. ' Both theories influence the lives of the public. I think it is relevant to state that the concepts of Classical economics came to be during the time of industrialization. It would seem at that time, the economy is self-sustaining and doesn’t need the government to obligation. Keynesian economics surfaced during the Great Depression. It would seem that during that time period, that the economy needs government intervention to stimulate our nation. Neither theory is absolutely right; however, bits and pieces of both are needed for an economy to strive. It is important for government intervention during an economic crisis, but they also need to know when it’s acceptable to step back and let the economy function on its own.
In recent years, it is obvious that our nation follows Keynesian theory more than Classical economics; an example would be government bailouts. Recently, the government felt it was necessary to intervene with the economy to motivate it back to the pre-NYSE-crook-days. Clearly we are still working out the kinks, but the government is still there embracing our economy during this tough time. I am not saying that Keynesian theory is the best choice. Honesty, Classical theory would be the best choice, but there is no way to convince our society, or any society, to go for it. People wouldn’t take the pay cuts, even if that means all their costs would decrease too, people would only see the detail that they are earning less money. Human greediness would not permit it, causing Classical economics to be something of the past and an core structure for economic theory, but not well experienced any longer; a great, former, idea. Now that the theorists have considered human nature into the mix we have generated Keynesian economics. If our society could recognize that our economy goes in waves. You cannot always be a booming nation, and look towards long-term goals, rather than trying to fix the problem right now, we would be much better off as a nation.
Nikaido, Hukukane. "Transition from the classical to the Keynesian Perspective." European Journal of the History of Economic Thought 8.4 (2001): 526-546. Academic Search Complete. EBSCO. Web. 6 Apr. 2011.
Kates, Steven. "SAY 'S LAW AND THE GLOBAL FINANCIAL CRISIS." Quadrant Magazine 54.8 (2010): 64-68. Academic Search Complete. EBSCO. Web. 6 Apr. 2011.
Widmaier, Wesley. "The Keynesian Bases of a Constructivist Theory of the International Political Economy." Millennium (03058298) 32.1 (2003): 87. Academic Search Complete. EBSCO. Web. 6 Apr. 2011.
Cited: Nikaido, Hukukane. "Transition from the classical to the Keynesian Perspective." European Journal of the History of Economic Thought 8.4 (2001): 526-546. Academic Search Complete. EBSCO. Web. 6 Apr. 2011. Kates, Steven. "SAY 'S LAW AND THE GLOBAL FINANCIAL CRISIS." Quadrant Magazine 54.8 (2010): 64-68. Academic Search Complete. EBSCO. Web. 6 Apr. 2011. Widmaier, Wesley. "The Keynesian Bases of a Constructivist Theory of the International Political Economy." Millennium (03058298) 32.1 (2003): 87. Academic Search Complete. EBSCO. Web. 6 Apr. 2011.