Classical vs Keynes
The Classical model of the economy says that all markets always clear. The labor market failing to clear does not exist in the Classical model because of competitive exchange equilibrium in which prices and quantities always adjust perfectly. The Classical model is of a closed economy and the variables are real output, employment, real and nominal wages, the price level, and the rate of interest. It is easier to understand the classical model using five diagrams that are numbered one through five in Appendix One, The Classical Model. These diagrams represent the separate parts of the model that together illustrate, for the most part, the entire Classical model. Diagram one represents the production function, which shows the assumption that real output, y, is determined by the level of employment, N. So y is a function of N and from the slope of the function we can see that output rises as employment is increased. But there is a diminishing marginal productivity of labor, which means that each time employment increases, the increase in output will get smaller and smaller. Diagram one illustrates the relationship between output and employment in the short run, but does not determine the level of output or the level of
Diagram five determines the interest rate, r, which is expressed as a percentage per period and depends upon the interaction of the savings and investment functions. The investment function, I, shows that the lower the rate of interest, the higher the amount of investment. The savings function, S, shows that the higher the rate of interest, the more will be saved. Because of the Classical dichotomy, diagram five is basically to show the breakdown of the use of income, or the demand for output, between expenditure on consumption and new capital goods. Because of the different effects that money has on the economy in these models, they arrive at different conclusions. The Classical economy seems to be in favor of no policy since everything works itself out and ends up in equilibrium since all the markets clear. The opposite is true for the Keynes model, where they are in favor of government intervention since it is not inherently self-regulating and the markets do not clear. The Keynes model needs a little help from the government, or the central bank, to achieve equilibrium, where as the Classical model, assuming all assumptions were realistic, is self-regulating and all markets clear. Like the Classical model, the Keynes model can also be explained by using five diagrams that are shown in Appendix Two, Keynes model. This is about the only similarity between the two. In the Classical model, all markets cleared. This is not true for the Keynes model, where flexible wages and prices do not bring about simultaneous market clearing, which means its not inherently self-regulating. The labor market will not clear in the Keynes model, which can be seen in Diagram five that shows involuntary unemployment. Also, the arguments are not connected to wage and price rigidity as they are in the Classical m
Some common words found in the essay are:
Classical Model, Appendix Keynes, , classical model, real wage, price level, keynes model, aggregate demand, labor market, real output, level employment, monetary sector, diagram five, classical aggregate demand, aggregate demand curve, labor supply function, using five diagrams, labor market real,
Approximate Word count = 1238
Approximate Pages = 5 (250 words per page double spaced)
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