Understanding Classical vs Keynesian Theory in Macroeconomics

Every government needs some basic framework to run the economics of its country.

Undoubtedly, there have been various beliefs about which kind of approach offers the best benefits to an economy. With time and with growth in global commerce, many of these policies were put to the test, and while some failed, some others still exist to this day. In this segment, we will take a look at some of the important policies.

The debate between Classical and Keynesian theorists has been ongoing for decades. Any understanding of macroeconomics would be incomplete without an understanding of the roots of these economic theories. In the upcoming video, we will take a look at some of the facets of these theories and learn how they have shaped our view of the functioning of an economy over the years.

So, the video gave you a broad overview of the Classical theories of economics. Now, Say’s Law of Markets states that ‘supply creates its own demand’, arguing that even if there is overproduction in an economy, demand will be created automatically. 

In the video, you learnt that the modern economy does not agree completely with the Classical Theory, which is based on the ‘Laissez-Faire’ Principle, which believes that non-intervention of government would lead to more socially desirable economic outcomes. 
 

Now, in the next video, we will take a look at the reason why this theory is not as widely accepted today as it was in the 19th century.

So, in the video, you learnt that Laissez-Faire theories did not do a good job in moving a country out of financial depression, could not explain the great depression and that they do not always ensure socio-economic welfare. 

Therefore, most countries moved away from this approach and adopted the more modern Keynesian theory. In the video, you learnt how these two theories differ in their approaches to analysing the way economies operate and grow. 
 

Unlike the Laissez-faire approach, John Maynard Keynes’ theory states that supply cannot create its own demand, but that ‘demand creates its own supply’. Keynes argued that aggregate demand drives production in an economy.
 

It was the Keynesian Theory that helped the United States come out of ‘The Great Depression’. This theory believes that in a recession, the government should intervene and should inject money into the economy.

Additional Learning

• Read this article for a brief overview of Keynesian economics
• Read this article on The Guardian website for a fresh look at why Keynesian economics still holds value in today’s age