The Keynesian Theory
The Keynesian theory is mostly known for being the first economic theory to challenge the traditional economic ways of operation and win. The theory was coined at a time when the ideas of neoclassical economics were the most valued by both scholars and business people around the world. Keynesian theory brought about the idea of public involvement in market control, something that did not exist within the economic filed at the time. People upheld the notion that the economic world would achieve natural equilibrium through natural forces, thus eliminating the need for public involvement in dealing with matters that affect the economies of the world like employment, demand, and supply. Keynesian theory brought a new dimension of economic understanding where the public had a role to play in influencing demand and supply in the market. The idea was received with a lot of criticism, especially from neoclassical economists who saw the suggestions of Keynesian theory as quick fixes that could not sustain the economy long enough (Evans, T. 2009, 2). In this connection, this paper aims at presenting a contrast between Keynesian and neoclassical economic theories in relation to human behavior, theories of money and unemployment.
The Keynesian theory appreciates the normal functioning of humanity in the social context while the neoclassical theory presents the economic man quite different from the normal human being. According to neoclassical theory, people make decision independently based on the information they have while based on Keynesian theory this is not the case. Before Keynesian revolution, employers were using this approach to influence employee decisions on wage and other work related issues. Employers and business people advocated for the abolishment of groups and government agencies that advocated for employee rights arguing that these forces would bring about imbalances between demand and supply within the market (Evans, T. 2009, 13). By letting people operate individually, the employers could cut down wages without getting a lot of fight from employees thus raising the demand levels.
The Keynesian theory suggests that the public has the right to represent the interests of the people to avoid mistreatment of the masses by the wealthy. The Keynesian theorists saw this approach as a mechanism for the rich to continue reaping the benefits of the economy at the expense of the poor rather than an economic solution to demand and supply. The Keynesian theorists did not believe in the natural equilibrium between demand and supply, therefore, cutting down wages based on the neoclassical assumption of human behavior was misguided. This is because people would still refuse the low pay even without having a group or public influence.
In relation to money, the Keynesian theory suggest the involvement of the government in interest reduction while neoclassical economics argues that it is the duty of firms to maximize profits while the individual maximizes utility. Based on neoclassical theory, the private sector does not need much help from the government to ensure economic circulation in both financial and production areas. Keynesian theorists argued that in reducing interest rates for the banks, the government would be giving the banking sector the mandate to extend the same courtesy to the public hence dealing with money issues. The monetary policies of neoclassical theory are based on an assumption of exaggerated demand for goods by the theory (OECD 2009, 115). Neoclassical theorists believed that as long as supply was maintained at a limited level, demand would always be there hence achieving a laissez faire situation in the market. However, the early days of the twentieth century was characterized by tremendous population growth and technological developments that affected the economic equilibrium hence the evolution of Keynesian theory.
The two theories differed greatly on their ideas of solving unemployment or creating employment opportunities for that matter at a time that the Britain economy was badly affected. The ideas of neoclassical theories did not appear to provide immediate solution to a problem that needed immediate response. This is because the major differences between these two theories is their approach in solving economic issues where the Keynesian theory provides short time solutions while the neoclassical theory focuses on long term solutions. Neoclassical theory argues that as prices go down so do the wage demands. According to this economic view, it is the duty of the business people to manage the situation of unemployment by reducing the prices of goods and services. Low produce prices will mean low expenses on employees’ part thus leading to reduced wage demands (Froyen, R. 2009, 56). However, the prices would need to remain low for this principle to work without which companies would have to lay off some of their employees leading to unemployment. The Keynesian economists saw the public involvement in economic affairs and market regulation as the solution to such predicaments of unemployment.
Keynesian theory argues that demand does not always result in equal product capacity. As such, too low or unmet demands can lead to adverse effects on inflation, employment, and organizational productivity. Proponents of Keynesian theory argue that demand is influenced by the private and public sector rather than the private sector alone as neoclassical economists argue. Additionally, deficiency of demand can arise from unemployment and increased prices something that can cripple an economy. Therefore, the Keynesian theory sees the public sector as having the potential to deal with unemployment issues through the government. The government can offer public related jobs to the public to help jump start a dying economy rather than waiting on the economic and consumer forces. Both theories admit that a nation’s economy is made up of business investment, consumer spending and government spending. However, they differ in the levels at which the government should be involved in regulating and managing the economy (Froyen, T. 2009, 127). The neoclassical see government involvement as an economy-crippling agent while the Keynesian theorists see the government as the viable solution in times of economic recession.
The neoclassical economists can criticize the Keynesian theory on many bases. First, the suggestions and the ideas of the theory only provide short-term solutions to economic issues in a foolish way. The stability of an economy depends on its ability to come up with long lasting solutions to its problems. Additionally, the mixed economy strategy where the government has the mandate to offer economic solutions deprives the monetary policy the ability to stabilize output. Issues such as current profit to investments and taxes and budgets to consumption would be irrelevant in an economic state as suggested by Keynesian. Some of the opponents of the Keynesian theory view it as a political appeal rather than an economic appeal (Berry, S. et al. 2007, 379). In other words, the Keynesian theory ignored all the economic principles of the time especially those that ensured that the economy sustained itself without external help.
However, regardless of the many criticisms of the Keynesian theory, it led to a great revolution in the economic world. First, the revolution gave governments a policy basis in economic affairs something that the neoclassical economists and other schools of economics did not allow. Additionally, raising the government’s involvement capacity in economic affairs helped deal with cases of extremists that had began happening in some parts of Europe. As a result, the theory became the basis of solution to major economic issues, for instance, the financial crises of 2007-2010. The monetarism theory was also born out of Keynesian theory. Generally, one can confidently say that the theory has had a significant impact on the global economy in many ways (Berry, S. et al. 2007, 386). In the end, the ideas of Keynesian theory together with some ideas of neoclassical theories were used to form the neoclassical synthesis.
In conclusion, the Keynesian revolution was a notable period in the economic world as it brought about the economic changes that have gained roots in the current world and have helped stabilize the economy. It took time for the rest of the economists to agree with Keynes ideas simply because change is always hard in every situation. However, the amalgamation of the ideas from both Keynesian theory and neoclassical theory has provided the best economic solutions to the current world. The idea of government involvement in economic affairs is ideal because it ensures equal distribution of wealth. In the other hand, allowing the market to balance its input and output prevents government borrowings that can cripple an economy if not wisely carried out.
Berry, S., Harrison, R., Thomas, R., and Weymarn, L., 2007. Interpreting movements in broad money. [Online] Available at: http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb070302.pdf [Accessed on 13 Nov. 2014].
Evans, T. 2009. Money and finance today. In: J. Grahl (Ed). Global finance and social Europe. Cheltenham: Edward Edgar publishing. 1-28.
Froyen, R., 2009. Macroeconomics: theories and policies. Upper Saddle River, N.J: Pearson Prentice Hall.
OECD., 2009. The effectiveness and scope of fiscal stimulus. [Online] Available at: http://www.oecd.org/eco/outlook/42421337.pdf. [Accessed at 13 Nov. 2014].