Keynesian Economics vs. Classical Economics: What's the Difference?

Keynesian Economics vs. Classical Economics: What's the Difference?

Compare and contrast Keynesian and Classical economics with this informative guide. Understand the differences between these two popular theories to make more well-informed economic decisions.

The distinction between Keynesian and Classical economic theories is one of the most debated topics in economics. Both theories offer different explanations on how an economy works, as well as different philosophical views on government spending, taxation, and business cycles. In this guide, we'll explain the fundamental differences between Keynesian and Classical economics to help you make more informed decisions about your finances.

Overview of Keynesian Economics.

Keynesian economics, also known as "big government" or demand-side economics, is an economic theory by British economist John Maynard Keynes that uses active government intervention to address supply-side shortcomings and decrease unemployment. The theory emphasizes public spending and borrowing to fuel economic activity during periods of slow growth or recession. It's based on the notion that governments have control over aggregate demand and can strategically intervene in areas such as taxes, spending, and business regulations to manage inflation and unemployment rates.

Keynesian economics stands in contrast to the traditional laissez-faire philosophy of Classical Economics. Unlike Keynesian economics, which calls for government intervention to address economic problems, Classical Economics focuses on individual actors and how they interact with one another—not governments or government policies. Under this framework, individuals compete in an open market that is self-regulating and dictated by natural forces–no external intervention is necessary (or beneficial). This ideology has been around since the 18th century and is still considered the foundation of modern economic thinking today.

Overview of Classical Economics.

Classical economics is an economic theory developed in the late 18th century by economists such as Adam Smith, Thomas Robert Malthus and Jean-Baptiste Say. This theory emphasizes that markets are self-regulating and governments should not intervene in economic activity. According to the theory, individuals have complete autonomy over their productive resources, so governments should not interfere with the market's equilibrium of supply and demand through fiscal or monetary policies. Furthermore, classical economists believe that given this equilibrium, economic growth can result from innovative entrepreneurs rather than government intervention.

Classical economics focuses on the free market and supply and demand, while Keynesian Economics (sometimes called neoclassical economics) is based on the idea that if demand falls short of total output, governments should step in with fiscal policies. While Classical economists believe there should be limited or no government intervention in the market, Keynesian Economics posit that government spending can help jump-start an economy out of recession by increasing demand. Furthermore, while Classical Economics assumes rational decision-making by individuals and businesses, Keynesian theory acknowledges that some economic actors may not always behave rationally. Both approaches have advantages and disadvantages when it comes to creating economic stability, which must be weighed carefully before deciding which policy to pursue.

Differences between Keynesian and Classical Economics.

There are several differences between Keynesian and classical economics. In contrast to the principles of classical economics, Keynesian economics is characterized by government involvement and influence on economic activity. Unlike the belief of classical theorists, who argued that governments should remain out of economic markets unless absolutely necessary, Keynesianism advocates scheduled injections of money into the economy to jumpstart spending and consumption. In addition, Keynesians believe that markets may not completely self-regulate at times and that government intervention can be beneficial in a number of ways such as creating jobs, funding public works projects, or providing social safety nets during recessionary periods.

Keynesian economics also advocates for higher levels of taxation for businesses and individuals to discourage hoarding. In contrast, classical economics encourages low taxes that would lead to increased investment and consumption. Keynesian economists also tend to think that government spending should be increased during hard economic periods, while classical economists argue that the opposite is true – that it should be cut back. Finally, Keynesians believe in a more flexible form of monetary policy, while classical economists advocate a more rigid approach involving strict rules and regulations.

Interests Rates: The Key Factor in Differentiating Theories.

The main difference between Keynesian and classical economics lies in the way they view interest rates. Classical theorists thought it was best to leave interest rates untouched, but Keynesians recognize that adjustments to the rate of borrowing influence economic decisions made by individuals and companies. For example, cutting interest rates increases the money supply, which can lead to more spending in the economy, creating jobs and stimulating growth. Similarly, increasing interest rates makes money more expensive for borrowers, causing them to save and draw back on their level of spending. Thus, adjusting interest rates serves as a beneficial tool for governments who are looking to fine-tune their economies and control inflationary pressures.

Ultimately, Keynesian economics places more emphasis on the role of governments in managing the level and distribution of economic activity. Governments should actively intervene in the economy to prevent large economic downturns instead of relying on market forces alone, which can exacerbate economic volatility. In contrast, classical economists believe that government intervention results in price distortion, misallocation of resources, and adverse unintended consequences such as excess debt. They also view government intervention as having minimal effect on creating more durable solutions to existing problems and lay more emphasis on free-market solutions for addressing and overcoming economic challenges.

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