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Q: Explain the viewpoints of classical and Keynesian economists. How did the economy that existed at the time of these theories influence them? Which theory is more appropriate for the economy today?
Why?
A: Classical Economics Assumptions Before working our way towards the workings of the Classical economics model, let us first know and understand the classical economics assumptions. [ The idea, is that like any theory, if the founding assumptions do not hold, the theory based on them is bound to fail. There are three basic assumptions of Classical Economics theories. They are: Flexible
Prices: The prices of everything, the commodities, labor (wages), land (rent), etc. must be both upwardly and downwardly mobile. Unfortunately, in reality, it has been observed that these prices are not as readily flexible downwards as they are upwards, due a variety of market imperfections, like laws, unions, etc. Say's Law: 'Supply creates its own demand'. The Say's law suggests that the aggregate production in an economy must generate an income enough to purchase all the economy's output. In other words, if a good is produced, it has to be bought. Unfortunately, this assumption also does not hold good today, as most economies today are demand driven (production is based on demand. Demand is not based on production or supply). Savings - Investment Equality: This assumption requires the household savings to equal the capital investment expenditures. Now it takes no genius to know, that this is rarely the case. Yet, should the savings not equal the investment, the 'flexible' interest rates should be able to restore the equilibrium. Keynesian Economics Assumptions Like all economic theories, the Keynesian Economics school of thought is based on a few key assumptions. Let us have a look at them first, before we progress on to the application of Keynesian economics in the actual economy. Rigid or Inflexible Prices: Mostly we see that while a wage hike is easier to take, wage falls hit some resistance. Likewise, while for a producer, commodity prices are easily upwardly mobile, he is extremely reluctant for any reductions. ]
cjam_1977|Points 290|
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Asked 12/27/2012 11:03:43 PM
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