Basic Macro Models: The Classical System and the Keynesian Revolution

“Markets respond to disturbances by changing prices and output to reach a new equilibrium. It’s automatic, a function of the ‘self-interest’ of market forces. A reliance on market mechanisms eliminates the need for any outside authority to try to influence prices or other behaviors.”

Really?

From Adam Smith to the Great Depression, this ‘Classical’ view of markets was used to further analyze the ‘macroeconomic’ world and resulted in a reliance on the markets’ self-correcting mechanisms. But with the Great Depression – in Europe and the United States – it seemed that markets, in fact, did not respond very well, or very quickly.

And so, in 1936, emerged John Maynard Keynes and his view that – for reasons explained herein – the belief in self-correcting markets was built on assumptions that were not supported by reality. Making, his arguments first, against the Classical assumptions of flexible prices (and wages), Say’s Law, and the role of interest rates, he then put forth his own ideas – changes in fiscal policies by the central government - that changed the world of economics.

At least for a time, …. Since the mid-1970’s – a resurrected ‘Neo Classical Economics’ if you will, has grown to dominate much of macro thinking and policy. Riding a tide of growing conservative thinking and politics, we have now had 40+ years to experiment and see if we can find where the truth exists.

This workbook takes this controversy and gives depth and understanding to Keynes’ thinking, as well as his criticisms of the laissez-fair approach to macroeconomic management. In four short chapters, using a very simple yet focused mathematical approach, students can grasp both sides of this controversy and make better sense of macroeconomics today – both in theory and in policy.

This workbook makes clear the use of fiscal policy and provides a starting point to debate its efficacy. It also serves to simplify the conservative approach to macroeconomic management and sets the stage for the pendulum swing also now existent into New Keynesianism.

Economics is filled with controversy. But the first step in addressing controversy is to understand the basic principles and assumptions involved. This workbook is preparation for the many debates of the macroeconomic world.