Keynes and the Classical Economists

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Keynes and the Classical Economists: The Early Debate on Policy Activism LEAR N I NG OBJ ECTIVE S 1. Discuss why the classical economists believed that a market economy would automatically tend toward full employment. 2. Explain why Keynes rejected the views of the classical economists. 3. Compare the views of Keynes and the classical economists with regard to the proper role of government. s you discovered in Chapter 10, unemployment and inflation impose costs on our society. Today, many Americans assume that it is the federal government’s responsibility to reduce those costs by combating unemployment and inflation when they occur. But the issue of government intervention to combat macroeconomic problems provokes sharp disagreement…show more content…
But the classical economists did not see saving as a problem. Saving would not cause a reduction in spending because businesses would borrow all Keynes and The Classical Economists: The Early Debate on Policy Activism 3 EXHIBIT 1 Say’s Law: Supply Creates Its Own Demand aid for resou 0 is p rce $10 s Businesses Households $1 00 is s pen t on goods and ser e vic s If all the income created in the act of producing output is spent by households, supply will have created its own demand, and all the output will be sold. the saved money for investment—the purchase of capital goods, such as factories and machinery. Why were the classical economists so sure that the amount households wished to save would equal the amount businesses wanted to invest? Because of interest rates. In the classical model the interest rate is determined by the demand for and supply of loanable funds, money available to be borrowed. If households desired to save more than investors wanted to borrow, the surplus of funds would drive down the interest rate. Because the interest rate is both the reward households receive for saving and the price businesses pay to finance investment, a declining interest rate would both discourage saving and encourage investment. The interest rate would continue to fall until the amount that households wanted to save once again equaled the amount businesses desired to invest. At this equilibrium interest rate there would be no uninvested
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