John Maynard Keynes was a British economist who studied the economy as whole as opposed to different parts of an economic system. He challenged the classical economic assumptions and its basic economic concepts and its explanations.
Keynes explained how the participants like Investors consumers behave and how the market system cannot always produce full-employment and how it cannot move to full employment at least in the short term without government intervention in the market system to keep the investment level and consumption level to produce closer to full employment. The classical market model and the price mechanism also was unable to explain the great depression 1930’s and Keynesian theory or the new Keynesian theory gave plausible explanation of recessions and boom and bust cycles of market economic systems and also gave prescriptions to stabilize these fluctuations by fiscal and monetary policy. In this sense as well as its considerable departure from the classical idea the market will self correct and government intervention must be minimum Keynesian economic thought emphasized the opposite that government has a legitimate role to pay in the market system to address the weaknesses in the market systems adjusting mechanisms of price signals at least in the
Keynesian Revolution short to medium terms to keep economic activity closer to full employment and redistribute income and wealth to the workers to increase aggregate demand. As Discussed above It can be said Keynes economic model and ideas and explanation how the system works is definitely a revolution to the classical economic model which adds to the knowledge and refined the understanding of how an economic system works as a whole and how the parts are related.
The economic forces which brought about Keynesian Economics
The main economic force behind the Keynesian economics was the observation that the economy for several reasons due to economic shocks or lack of consumption if it produces unemployment temporarily the market system left to correct such imbalances did not produce employment levels closer to full-employment and the economy went through boom and bust cycles when the economy grows and there was considerable fluctuation in economic activity at least in British economic history. In order to understand such economic phenomena Keynes developed his Keynesian Economic model and created his Economic theory called The General Theory of Employment Interest and Money. In addition the Great depression in 1930’s gave great concerns about how to correct such low levels of employment and misery and how to avoid it by appropriate economic policy.
Revolutionary Nature of Keynesian Economics
Keynesian Economics is not studying a part of economy but to study the economy as whole and see how the parts are related. It gave a radically new model of the economy, changed the behavior of consumers assumption that they are rational to impulses and animal instincts as well it modified the functions of money that it can be a store of wealth as well as a medium of exchange It also theorized that investment level does not only depend on interest rate but on the expectations and outlook of investors future and gave a plausible explanation why price will not adjust so that to produce full employment because of Institutional factors and other factors prices will not fall to increase demand but produce more unemployment .
In effect Keynesian theory gave why economy can come in to equilibrium less than the full employment level and can move through boom and bust cycles if allowed to work in the mercy of the market alone and the price mechanism. That is Keynesian economics gave governments a legitimate economic role to manage the economy close to full employment by Keynesian economic policy. In this regard as the earlier economic theories do not explain the above economic problems and Keynes gave some more insights which is radically different from the earlier economic models it is a revolution in Economics.
The classical and Keynesian Economic theory of employment.
The classical economic theory assumes the economic participants are rational. Keynes rejects this assumption and believes the participants need not be fully rational and they can act on instincts and subjective judgments and intuition. In classical economics they don’t take in to account institutional factors but in Keynesian economics they take in to account institutional factors. Classical economists keep other things equal and study a specific economic relationship.
But Keynes economics they study the economy as whole and study all economic variables simultaneously. Classical economists believe price will self correct so that the economy will not be in unemployment for long period of time. Keynes rejects this and theorize that price stickiness in the market prevent the system to adjust to full employment level. In classical economics money is a medium of exchange but in Keynesian economics it is also a store of value. There fore in bad economic times
Consumers will not spend but save for liquidity preferences and this may reduce aggregate demand and further increase unemployment. The relation ship between interest rate and Investment level for classical economist is strong. That is interest rate will affect investment level than other factors. That is investment level is sensitive to interest rate than other factors but for Keynesians other factors are important than interest rate. In classical economics they see a very limited role for government in economic affairs. But In Keynesian economics they see a legitimate and far greater degree of intervention
The classical and Keynesian Economic theory of employment to regulate economic activity to create full employment. As well Keynesian economics like to redistribute income and wealth to increase aggregate demand but classical economists do not believe in the redistribution of income will produce more employment.
Keynesian explanation of the Great Depression
According to Keynesian economics the great Depression is caused by inadequate investment and aggregate demand and the market system did not have the level of consumption and investment demand so that the economy as whole produced high level of unemployment because there is less government investment to take the slack in private investment levels and the inequality of income in the market system which produces less aggregate demand compared to if the income distribution is more equal.
Keynesian Economic Policies
Keynesian Economic policies are fiscal and monetary policy. Fiscal policy is the use of taxes and government welfare and other infrastructure and investment programs particularly in a recession and finances it through borrowings as well as deficit financing.
In addition Keynesian economic policies are directed to trade policies to boost aggregate demand. In addition to that it uses interest rate to keep money supply under control to manage inflation and also to improve investment levels. However fiscal policy plays a major role in stabilizing aggregate demand rather than the use of monetary policy. In addition it also addresses the institutional factors, which makes the market to work more effectively so that government can regulate and minimize anti competitive practices.
Alan S. Blinder. “Keynesian Economics”. THE CONCISE ENCYCLOPEDIA OF ECONOMICS. THE LIBRARY OF ECONOMICS and LIBERTY. 28 nNov.2006
Steve, Kangas. “A Critique of the Chicago School of Economics: A BRIEF REVIEW OF KEYNESIAN THEORY”. The Long FAQ on Liberalism. Liberalism Resurgent. 28 Nov.2006
The Canadian Encyclopedia. “ Keynesian Economics”. The Canadian Encyclopedia. 28 Nov. 2006
wikipedia. “Causes of Great Depression”. Answers.com. 28 Nov. 2006
WIKIPEDIA, The Free Encyclopedia. “Keynesian Revolution”. WIKIPEDIA, The Free Encyclopedia. 28 Nov 2006