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Keynesian and Neoclassical Economic Theories

Neoclassical

Neoclassical economic school of thought emerged in the early 1900s from what is known as the Marginal Revolution. It was a response to the Classic economic theory which did not accurately reflect items on the market. Ideas began to form which based value on the relationship between a buyer and the object being sold, evolving in what is known as supply and demand.

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The neoclassical theory attempts to establish a balance amongst various economic agents in a free market. It is based on the primary principle that individuals seek to optimize utility while firms maximize profits. Consumers are independent in rationalizing their economic decisions based upon provided information and personal utility. Essentially, the value is determined by the point where the need and desire for an object meet constraints of scarcity and purchasing power. The balance is exemplified by prices, which are volatile and are modified based on the state of the market.

The current condition of the modern capitalist economy is largely based upon the fundamentals of the neoclassical tradition. Concepts emerging from this school of thought include rational choice and neoclassical growth theories that guide the mainstream economics approach to the free market. The neoclassical approach became so popular because it established equilibrium of optimization and fair distribution of goods based on truth and information, thus influencing social development. (Weintraub).

Neoclassical economics believes firmly in the self-regulating mechanism of the market. Government intervention is avoided, however, economists accepted that it is necessary to a certain extent. Arguments against the neoclassical approach include that the idea is too abstract, not considering the numerous real factors influencing the market. As shown in the 2008 recession, lack of regulation, rationality, and the belief that the market can withstand infinite profit maximization of profits led to unethical behavior and growth of synthetic financial instruments which led to a collapse (Bresser-Pereira).

Keynesian

The Keynesian school of thought is an economic theory that was developed by the famous economist John Maynard Keynes in the 1930s in an attempt to understand the causes of the Great Depression. It emerged as a direct contrast to the classical school of economics which focused on aggregate supply but could not explain the socio-economic depression of the time. Keynesian ideology is inclusive and encompasses many aspects of macroeconomics. It led to the emergence of other related schools such as New-Keynesian and Neo-Keynesian economics. However, the fundamental principles of Keynesian economics are utilized in modern-day in collaboration with the neoclassical approach to model the short-term economic performance in the post-recession era.

Keynesian economics is focused on short economic cycles, specifically recessions. Its primary focus is explaining the relationship between aggregate demand and economic output, also influencing factors such as inflation and unemployment. The productive capacity of the economy which is key to the economic output can be optimized, therefore leading to better stability and preventing deep recessions. Keynesian supporters believe in strong government intervention, specifically activist stabilization policy to influence aggregate demand. This is supported by the belief that fluctuations and cyclical macroeconomics impact socio-economic prosperity. Additionally, the federal entities have the ability and necessary knowledge to benefit the free market.

Aggregate demand can be influenced either by fiscal or monetary policy. Both seek to stabilize the volatile indicator of aggregate demand which is affected by both public and private economic decisions. Also, Keynesian theorists argue that prices and wages are sluggish in their response to economic factors. Changes in aggregate demand have the most influence on employment and productive output, focusing on the short-term fluctuations because people focus on their current well-being before anything else.

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Through active stabilization, Keynesian economists argue for lowering unemployment rather than focusing on combatting inflation. Low unemployment brings a slow rise in inflation; however, the opportunity cost is acceptable when aggregate demand increases. The fiscal policy so often utilized by politicians is justified in Keynesian thought only if the unemployment rate has accelerated significantly. Further, income tax cuts in attempts to urge spending usually have a detrimental effect and cut funding to numerous state entities and programs (Blinder).

Works Cited

Blinder, Alan. “Keynesian Economics.” Library of Economics and Liberty, n.d.

Bresser-Pereira, Luis. “The global financial crisis, neoclassical economics, and the neoliberal years of capitalism.” Revue de la Regulation, vol. 7 no.1, 2010.

Weintraub, Roy. “Neoclassical Economics.” Library of Economics and Liberty, n.d.

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