![]() ![]() In other words, if a good is produced, it has to be bought. The Say’s law suggests that the aggregate production in an economy must generate an income enough to purchase all the economy’s output. Say’s Law: ‘Supply creates its own demand’. ![]() Unfortunately, in reality, it has been observed that these prices are not as readily flexible downwards as they are upwards, due a variety of market imperfections, like laws, unions, etc. Flexible Prices: The prices of everything, the commodities, labor (wages), land (rent), etc., must be both upwardly and downwardly mobile.The idea, is that like any theory, if the founding assumptions do not hold, the theory based on them is bound to fail. Adam Smith’s book, ‘The Wealth of Nations’, that started a worldwide Classical wave, stresses on there being an automatic mechanism that moves markets towards a natural equilibrium, without the requirement of any intervention at all.īefore working our way towards the working of this model, let us first know and understand the assumptions. The Classical economics theory is based on the premise that free markets can regulate themselves if left alone, free of any human intervention. Many others (David Ricardo, Thomas Malthus, John Stuart Mill, William Petty, Johann Heinrich Von Thunen, etc.) have come and gone, and added a few things here and there, to the classical theories. I (Adam Smith) have never known much good done by those who affected to trade for the public good.” – Adam Smith (1776), An excerpt from ‘An Inquiry into The Nature and Causes of The Wealth of Nations’.Īdam Smith is a great economist, who is known as the founder of the classical economics school of thought. “By pursuing his own interest, he (man) frequently promotes that (good) of the society more effectually than when he really intends to promote it. Also understand, that even if it may seem so in this particular article at times, one cannot conclude that Keynesian economics is flawed or classical economics is flawed (there’s no absolute right and wrong in economics, different theories are applicable under different economic assumptions).ĭefinition and Groundwork for the Classical Economics Model By the way, I am an out-and-out Classical economist, so forgive any biases that might creep in. Let us start with a general overview of what this school of thought propagates. This is considered to be the first school of economic thought. But while Keynes argued for corrective Government intervention, Classical theorists relied on people’s selfish motives to sort the system out.įor a much better understanding of the difference it is essential that we delve a little deeper and try to understand the basics of these two approaches. Both Keynes and the Classical theorists however, believed as fact, that the future economic expectations affect the economy.They are known to overshoot or undershoot at times as well. Keynes argued that interest rates do not usually fall or rise perfectly in proportion to the demand and supply of loanable funds. Keynes thought of savings beyond planned investments as a problem, but Classicists didn’t think so because they believed that interest rate changes would sort this surplus of loanable funds and bring the economy back to an equilibrium.The Keynesian economists actually explain the determinants of saving, consumption, investment, and production differently than the Classical. Keynesian economics does not believe that price adjustments are possible easily and so the self-correcting market mechanism based on flexible prices also obviously doesn’t. While Classical economics believes in the theory of the invisible hand, where any imperfections in the economy get corrected automatically, Keynesian economics rubbishes the idea.Keynes argues that this can only hold true if the individual savings exactly equal the aggregate investment. The strong form of the Say’s law stated that the “costs of output are always covered in the aggregate by the sale-proceeds resulting from demand”. Keynes refuted Classical economics’ claim that the Say’s law holds.► Difference between Classical and Keynesian Economics Economists who believe in either of the types of thoughts are at loggerheads about various aspects about the way the economy influences people and vice-versa. Macroeconomics considers the performance of the economy as a whole, which involves two major approaches to study the pattern and influence on the economy. ![]()
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