Keynesian Economics and the Great Depression - Essay Example

The pessimistic attitude of the customers and the investors results in less spending in the economy. The focus shifts from expenditure to saving more of the current income for future spending. Thus in reacting to this less expenditure on the part of the consumers and the investors, the firm will lower their production resulting in less output. Reduction in the wage rate of the workers in this circumstance will not contribute to the elimination of the huge unemployment rate prevailing in the economy. A simultaneous decrease in the interest rates in the economy will also not succeed in returning the economy to the original track (Gwartney, Stroup, Sobel, and MacPherson, 228).

Wages and interest rates are considered fixed in the Keynesian theory. According to the theory even if there is a decline in the wage rate a negative impact will be exerted on the economy through the reduction in income and hence reduction in aggregate demand. The Keynesian theory rejects the view of classical economists that market forces will bring back the system of full employment in the economy. Equilibrium in the economy will be reached when the total spending in the economy will be equal to the total output. Changes in output may drive the economy to a certain extent towards the equilibrium as opposed to price changes as suggested by the other stream of economists. (Gwartney, Stroup, Sobel, and MacPherson, 228)

Unfavorable supply shock results in the slowdown of the economy, raising the prices of commodities and making production less profitable. This can be an explanation for stagflation. Secondly, inappropriate macroeconomic policies can result in the stagnation of the economy along with high rates of inflation resulting in economic stagflation. These two factors simultaneously were responsible for the stagflation of the 1970s. (Stagflation) Classical and Keynesian economists have never thought of stagflation as they focus on the theory of the Phillips curve. Keynesian economists suggested that an increase in government expenditure might be the remedy for the economic phenomenon. Classical economists focus on the supply side of the economy predicting the market forces to clear automatically with less importance on the roles of the government. (Sabnavis, 21)

The main difference between the two streams of economists regarding the future and current policy implications centers on the role of the government. Focus on government intervention and policies for steering the economy have been advocated by Keynesian economists while classical economists focus on the free forces of the market economy. Say’s law best identifies the main difference between the two streams. Classical economists focus on the Says law in the determination of the fiscal and monetary policies of the economy (Keynesian and Classical Economics). The Keynesian economists on the other hand dismiss the law revealing the need for a separate analysis of the demand and the supply side of the economy. (Keynesian and Classical Economics) Read More