Keynesian economics refers to a theory of economics that is based on the principles of John Maynard Keynes, a popular English economist of the 20th century. His ideas were aimed at responding to the Great Economic Depression of the 1930s (Blinder, 2006). …
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Keynesian economic principles promote mixed economies in which both the state as well as the private sector will play significant roles. The emergence of Keynesian economics closed the curtain on laissez-faire economics that were based on the idea that markets as well as the private sectors could be able to operate independently without government intervention (Keynes, 1936). Keynesian economists believe in the government's role to level the business environment. State intervention may take the form of tax breaks and government spending with a view of stimulating the economy. In good economic times, government expenditure cuts as well as tax hikes would help curb inflation (Blinder, 2006). This paper advances Keynes’s theory that the best way to ensure economic stability and growth is by active government intervention in the marketplace and monetary policy.
Keynes differed with the Classical economic theories posing various arguments to disapprove them. Basically, Keynes believed that markets could not automatically attain full-employment equilibrium, but rather, the economy would settle in equilibrium at any given level of unemployment (Blinder, 2006). This implies that the classical principles of non-intervention by government would not apply. For the economy to grow in the correct direction, it would require prodding and this means active government intervention in order to manage the demand level. The Keynesian principles are illustrated on the basis of circular income flow. In case of disequilibrium between income injections and leakages, then, according to classical economists, prices would move to appropriately restore the equilibrium. However, Keynes principles that the output level (National Income) will adjust appropriately in attempt to restore equilibrium (Keynes, 1936). For instance, if, for some reason, there is a rise in income injections, say due to increased government expenditure, an imbalance would result between injections and leakages. Following the resulting extra aggregate demand, firms will tend to employ more persons and this would result in more income within the economy. Some of this income could be spent while some would be saved or remitted in tax. The extra expenditure is likely to prompt most of the firms in that economy to increase their production further creating even more employment opportunities and in turn increasing income within the economy. This process will continue until it finally comes to a stop. It would finally stop since with every increase in income, leakages’ levels also increase (tax, savings and imports). When income injections finally equal the leakages, equilibrium will be restored. This process, according to Keynes is referred to as the Multiplier effect (Blinder, 2006). Keynesian Theories Keynes suggested that it was not a perfect idea to rely on markets in order to attain full employment in the economy. He believed strongly in his view that economies can settle at any given equilibrium. As a result, there couldn’t be automatic changes that could correct equilibrium in the markets. The main theories used to justify the Keynesian view are: The labor market theory (the monetarist theory), the money market theory (market for loan-able fund theory), the Multiplier effect theory and the Keynesian Inflation Theory (Keynes, 1936). Monetarist Theory: The Labor Market To Keynes, wage determination is more complex. First, he pointed out that it nominal wages but not real wages that are often subjected to negotiations between workers and their employers such as in barter relationship. In the first place, it is very difficult to effect nominal wage cuts due
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