## Classical vs. Keynesian Economics

• 4.2k
Ok, so I know a we bit about economic theories, but I'm looking for people who really know their shit. Here are my questions:

1) How would a Keynesian and Classical economist differ in their view of government spending and aggregate demand and aggregate supply?

2) I have a premise: Inflation is due to micro-decisions of greed on the part of the supplier to maximize as much profit as possible without pricing themselves out of the market.

Please comment on both of these.
• 10.7k
1) How would a Keynesian and Classical economist differ in their view of government spending and aggregate demand and aggregate supply?

I'm not sure what you are asking here. Are you asking about distribution of taxation or social welfare?

2) I have a premise: Inflation is due to micro-decisions of greed on the part of the supplier to maximize as much profit as possible without pricing themselves out of the market.

Inflation, classically is defined as an overabundance of money to every individual in the market, creating an inflation in prices.

Regards.
• 4.2k
I'm not sure what you are asking here. Are you asking about distribution of taxation or social welfare?

No, for example, the US is spending trillions of dollars on aid and stimulus bills. Classical and Keynesian economists might differ on the efficacy of that.

Inflation, classically is defined as an overabundance of money to every individual in the market, creating an inflation in prices.

So yes, that is what inflation is, but it is not quite the cause of inflation. It's a necessary condition, but not sufficient. Something else besides more money, creates inflation. My theory was that because there is more money, suppliers anticipate this, or they see behaviors (like people being able to buy more), and then they see they can maximize more profit and increase their prices.
• 4.2k
@fdrake Maybe you can provide some ideas here.
• 2.5k

1) Keynesianism takes the view that the government can curb economic downturns by public sector replacing the falling aggregate demand in an economic recession. Classical economics simply takes the view that the economy simply has to get back to it's balance by the market mechanism and this implies that we have to bear that economic downturn. After it the economy is far healthier. Keynesian economics means that the government tries to manage the economic downturns and hence ease the depth of an economic recession or a depression. (And btw. Keynes talked about many issues, so "Keynesian" is rather a broad definition.)

2) I have a premise: Inflation is due to micro-decisions of greed on the part of the supplier to maximize as much profit as possible without pricing themselves out of the market.
Nope.

Inflation, the rise of prices, basically happens because when money loses it's value. If something is high in demand and the supply cannot meet up with it, that is normal market mechanism at work when the prices rise. In your example the supplier is just trying to find the optimum for his profit: higher prices mean less buyers, lower prices more buyers. What is the optimum is one of those things a supplier has to find. Inflation is a monetary phenomenon. Asset inflation is a bit different, but has the same mechanism behind it.
• 4.2k
1) Keynesianism takes the view that the government can curb economic downturns by public sector replacing the falling aggregate demand in an economic recession. Classical economics simply takes the view that there has the economy simply has to get back to it's balance by the market mechanism and this implies that we have that economic downturn. After it the economy is far healthier. Keynesian economics means that the government tries to manage the economic downturns and hence easy the depth of an economic recession or a depression.ssu

Yes, I know that, but I am talking very specifically here. So why would government spending be bad in classical economics? They think it will cause inflation and worse-off results. Keynesians would say that it does not necessarily cause inflation as it can only target certain sectors and not all at the same time.

Nope.

Inflation, the rise of prices, basically happens because when money loses it's value. If something is high in demand and the supply cannot meet up with it, that is normal market mechanism at work when the prices rise. Inflation is a monetary phenomenon. Asset inflation is a bit different, but has the same mechanism behind it.
ssu

So this debate came from a debate I had and I too was mentioning the classic inflation from money supply increase due to monetary policy from central banks. However, there is also demand-pull inflation which causes inflation from government spending (causing debt).

So usually more money is pumped into the system. But the actual increase in prices comes from certain human behaviors. JUST having more money in the economy doesn't in itself raise prices. What does raise prices is suppliers anticipating this increase in supply and/or seeing demand rise, and realizing they can make more money by increasing prices.
• 10.7k
So yes, that is what inflation is, but it is not quite the cause of inflation. It's a necessary condition, but not sufficient. Something else besides more money, creates inflation. My theory was that because there is more money, suppliers anticipate this, or they see behaviors (like people being able to buy more), and then they see they can maximize more profit and increase their prices.

Sounds Marxist. I'm sorry; but, modern day economics is based on rationality. To say that greed dictates the evaluation of prices or even price gauging (which is abhorred in economics) sounds fruity.
• 4.2k
Sounds Marxist. I'm sorry; but, modern day economics is based on rationality. To say that greed dictates the evaluation of prices or even price gauging (which is abhorred in economics) sounds fruity.

Um, what do you call it when someone raises prices on a customer because he can make a better buck, yet still has plenty for a good standard of living? Even so, take the greed part out.. my point was describing WHAT causes the raise in prices. If you want, it is simply the supplier increasing prices based on a perceived rise in demand.

Sounds fruity is not very rational itself, but certainly points to a trolling tendency. I'd use better descriptors.
• 10.7k
Um, what do you call it when someone raises prices on a customer because he can make a better buck, yet still has plenty for a good standard of living?

A monopoly?

Even so, take the greed part out.. my point was describing WHAT causes the raise in prices.

Essentially, a market failure or lack of competition in neoclassical economics.

If you want, it is simply the supplier increasing prices based on a perceived rise in demand.

Yeah, that can be true.
• 4.2k
A monopoly?

No that's not a monopoly, that is increasing prices. Any business owner can do that.

Essentially, a market failure or lack of competition in neoclassical economics.

No you can have any type of company raise prices if they perceive a higher demand.

Yeah, that can be true.

Cool
• 10.7k
No that's not a monopoly, that is increasing prices. Any business owner can do that.

In a market, where there is competition in contrast to a monopoly that dominates the market segment it exists in, there's can't be arbitrary rises in prices for goods provided by said rational agent.

No you can have any type of company raise prices if they perceive a higher demand.

See above.
• 4.2k
In a market, where there is competition in contrast to a monopoly that dominates the market segment it exists in, there's can't be arbitrary rises in prices for goods provided by said rational agent.

All the companies would raise their prices.. this is why I said micro-decisions affect the whole thing.. all companies will eventually raise prices with increase raise in demand.. this will affect yet other companies downstream who will need to raise prices due to increased costs, and on and on.
• 10.7k
Please keep in mind, that despite the difference in names, Keynesian economics is put simply, an extension of neo-classical economics, that simply differently addresses the issue of market failures (in an active manner).
• 10.7k
All the companies would raise their prices..

Yes, in an oligopoly they would, if there were some hidden agreement among participants.

this is why I said micro-decisions affect the whole thing.. all companies will eventually raise prices with increase raise in demand.. this will affect yet other companies downstream who will need to raise prices due to increased costs, and on and on.

Perfect knowledge would allow that, which leaves two things as possible, either a conspiracy or an event outside the realm of market supply or demand.
• 4.2k
Perfect knowledge would allow that, which leaves two things as possible, either a conspiracy or an event outside the realm of market supply or demand.

It's not perfect knowledge.. If you give people $1200 and they spend it on consumer goods.. those companies start perceiving an increase in demand. They do a calculation to see if they would make more money raising prices because they know people are buying more. They raise it enough to make more money without losing too much business.. The profit increases marginally the prices raise marginally, you have inflation. • 10.7k It's not perfect knowledge.. Well, there's an implicit assumption made here. Let me elucidate. If you give people$1200 and they spend it on consumer goods.. those companies start perceiving an increase in demand.
If all people started buying goods with such new disposable income, then, yes, there would be a rise in prices.

They do a calculation to see if they would make more money raising prices because they know people are buying more. They raise it enough to make more money without losing too much business.. The profit increases marginally the prices raise marginally, you have inflation.

Who does the calculation? Again, you're assuming the invisible hand is all knowing, which is a common misconception of economics.
• 4.2k
Who does the calculation? Again, you're assuming the invisible hand is all knowing, which is a common misconception of economics.

Well, actually that's my point kind of. Inflation is simply collective decisions over time of micro-decisions that are based on suppliers trying to make more profit..
• 10.7k

Well, that would be true if an event in the market caused a uniform rise in prices. Such events are extremely rare, or a collusion between market suppliers is complete.

But, then again, look at the increase in prices in N95 masks due to something unforeseen as Coronavirus.
• 4.2k
Well, that would be true if an event in the market caused a uniform rise in prices. Such events are extremely rare, or a collusion between market suppliers is complete.

But, then again, look at the increase in prices in N95 masks due to something unforeseen as Coronavirus.

So you hit on something that Keynesians might say.. that inflation is not all at once but from only a few sectors thus not raising all prices. Classical economics would tend to say that government spending (that is not there.. deficit spending in other words) would create unnecessary inflation that would simply raise prices overall on supply due to suppliers seeing increase in demand. Or that is how I've heard it. If someone else wants to chime in and correct me, feel free to do so.
• 10.7k

I haven't read Keynes's General Theory; but, to the best of my knowledge, they would implement in an active manner a price ceiling, if goods were becoming too expensive for all rational agents. This would be accomplished by subsidizing goods.

In neo-classical economic theories, I suspect that given they want, through laissez faire, the market to correct itself. An ideal that never really works or ever worked.
• 4.2k

Keynesian theory is always looking for where things don't actually clear.. sticky wages, uneven inflation, etc. This is where governments can step in to promote this.. it is more demand side economics, not supply side.
• 10.7k
Keynesian theory is always looking for where things don't actually clear.. sticky wages, uneven inflation, etc. This is where governments can step in to promote this.. it is more demand side economics, not supply side.

Keynesian economics assumes that prices are elastic. I'm not sure where you're getting the notion that prices are inelastic. Even the prices for core goods are elastic. Again, you'd require something really extreme of an event to cause a uniform rise in (core) goods, where competition is rife.

What you might or as it seems to me, getting at, is a collusion in the market. Is that so? This is where Keynes is superior to laissez faire economic theories, with government oversight over the fluctuation in prices.
• 4.2k
Keynesian economics assumes that prices are elastic. I'm not sure where you're getting the notion that prices are inelastic. Even the prices for core goods are elastic. Again, you'd require something really extreme of an event to cause a uniform rise in (core) goods, where competition is rife.

I'm not saying they are not elastic. I'm not sure where you're getting that. I'm saying that more demand increases prices.. We know that.. but why? Suppliers raise prices.

What you might or as it seems to me, getting at, is a collusion in the market. Is that so?

There is definitely that in gas prices and such, but price increases don't have to happen because of that. An economist who tries to give the benefit of the doubt will say that the price increases are due to increased capital and employment to make more supplies. That may be the case. However, there is just good ole fashion seeing how much one can make knowing the increase in demand is occurring. The tendency seems to be mechanization anyways, which would stabilize more, or less the costs from labor, and then it would really just be doing calculations on how much you can raise prices before you lose money on less sales.
• 2.5k
. So why would government spending be bad in classical economics? They think it will cause inflation and worse-off results. Keynesians would say that it does not necessarily cause inflation as it can only target certain sectors and not all at the same time.
Classical economics was before Keynes and Keynes himself wasn't so much against classical economics, with the exception of being against Say's law. I think that today many economic schools are against Keynesianism and governments taking on debt, but these are contemporary schools of economic thought. Many in the Austrian school for example don't like Keynes, as you might know.

Even Keynes admitted that government spending has to be in the long term balanced, but who would then at the time of the economic upturn save money for a rainy day? Usually the times of strong economic growth are seen as a goldilocks economy or the "new economy". I remember quite well some time ago before the "Great Recession of 2008" commentators saying that economic fluctuations are a thing of the past. Above all, one should understand that economics is far closer to it's old name, political economy, and politics does play here part. Economists think that they can handle these issues without involving politics into the equation, but it simply isn't so.

However, there is also demand-pull inflation which causes inflation from government spending (causing debt). - What does raise prices is suppliers anticipating this increase in supply and/or seeing demand rise, and realizing they can make more money by increasing prices.
Well, I may be here so "old-school" that what you explained still sounds like normal market mechanism working. You can call it demand-pull inflation (or cost-push inflation), but I wouldn't use those terms as it confuses a bit the terms in general. As if anything raising the prices is inflation and anything lowering the prices is deflation. If there's an exceptionally good harvest or a catastrophic harvest failure, I wouldn't call the price decreases or increases a sign of deflation or inflation. But of course you can use the economic terms demand-pull and cost-push inflation.
• 4.2k
Well, I may be here so "old-school" that what you explained still sounds like normal market mechanism working. You can call it demand-pull inflation (or cost-push inflation), but I wouldn't use those terms as it confuses a bit the terms in general. As if anything raising the prices is inflation and anything lowering the prices is deflation. If there's an exceptionally good harvest or a catastrophic harvest failure, I wouldn't call the price decreases or increases a sign of deflation or inflation. But of course you can use the economic terms demand-pull and cost-push inflation.ssu

This comes out of an argument whereby the person was against the government spending because, he claimed, it would cause inflation. That just got me thinking about how exactly inflation works. Just by saying that more money is injected into the economy causes inflation doesn't get at it. WHY does more money injected cause inflation? Because people will buy more. This demand will cause one of two things 1) suppliers to need to spend more on resources to create the supply for more demand or 2) suppliers to see an opportunity to make more money by increasing prices. I was addressing number 2 and saying that was possibly a large part of it.. There are no laws in economics that are not actually tied to human preferences, behaviors, and the like. Prices don't increase just because, but because people are deciding to do things.
• 2.5k
WHY does more money injected cause inflation? Because people will buy more.
Actually ordinary people are the last one's in the line.

When the central bank prints more money or devalues it's currency, the first ones to benefit from this are the banks and the large corporations (or in the case of devaluation the companies making exports). They will get more money to spend it first. And when they go after those natural resources etc. that cannot be simply printed more, then market mechanism kicks in and prices rise. This in turn makes things then more costly. Finally the workers notice that their wages aren't keeping up with the prices of goods and they demand a raise, if they are in the position to do so. And once those wages go up, the central bank can then accuse the workers of creating inflation because of their excessive wage demands!

And you are correct that more money injected to the economy doesn't always cause inflation. In the last financial crisis the banks simply used that money to prop up their holdings. And who would take a loan in a time when the natural thing would be to save and be parsimonious? If you are worried that you might loose your job or have lost your job, the last thing people usually do is go and spend more than before.
• 4.2k
And when they go after those natural resources etc. that cannot be simply printed more, then market mechanism kicks in and prices rise. This in turn makes things then more costly.ssu

This is basically what I am talking about.. So what does this mean "market mechanisms kicks in and prices rise"? Suppliers raise the prices to invest in more output or because they think they can make an extra buck. THIS causes prices to rise. Again, it is human behavior. Saying things like "market mechanisms" tries to take the human behavioral element out of this.

Finally the workers notice that their wages aren't keeping up with the prices of goods and they demand a raise, if they are in the position to do so. And once those wages go up, the central bank can then accuse the workers of creating inflation because of their excessive wage demands!ssu

True although wages going up barely happens or happens at the rate of the inflation of prices.

And you are correct that more money injected to the economy doesn't always cause inflation. In the last financial crisis the banks simply used that money to prop up their holdings. And who would take a loan in a time when the natural thing would be to save and be parsimonious? If you are worried that you might loose your job or have lost your job, the last thing people usually do is go and spend more than before.ssu

Yeah, savings is a factor classical economics doesn't take in making non-equilibrium.
• 2.5k
This is basically what I am talking about.. So what does this mean "market mechanisms kicks in and prices rise"? Suppliers raise the prices to invest in more output or because they think they can make an extra buck. THIS causes prices to rise. Again, it is human behavior. Saying things like "market mechanisms" tries to take the human behavioral element out of this.
Ok schopenhauer1, now I can really say that this is economics 1.0. That's why I called it "market mechanism kicks in". When there far more demand than supply, then prices go up. It might not be the individual supplier that raises the prices, it may be the buyer that knows that there's a shortage and simply offers to pay a higher price. Markets are a two way street, you know. It's very naive to think that in a shortage situation it's the suppliers that are raising the prices because of greed.

Again, it is human behavior. Saying things like "market mechanisms" tries to take the human behavioral element out of this.
What makes it a "market mechanism" is the amount of people involved making good (or bad) judgements. That's why we talk about aggregate demand and supply, macroeconomics vs. microeconomics. Not everyone makes good choices. But on average, people are reasonable. And before you say it, yes, there are Animal Spirits as Keynes himself said. Hence many times that market predict things wrong.

True although wages going up barely happens or happens at the rate of the inflation of prices.
Especially now. You see, in the case Weimar Republic and Zimbabwe the government printed money to to pay salaries and direct government purchases. That money goes straight into the economy. This comes public (that the government is printing money to pay it's bills) and the people do understand this and the faith on the currency starts to falter. That causes hyperinflation. That is a different case. In the financial crisis the money went to prop up the banks, basically to pay for the bad loans they had lent. The money didn't hit the economy, hence no inflation.

Now it's likely that the cash given to people won't affect much prices as there is the economy is plunging. For the moment. It's interesting to see what happens.

Yeah, savings is a factor classical economics doesn't take in making non-equilibrium.
Is the economy anytime in an equilibrium? I see it always going somewhere, up or down...
• 4.2k
Ok schopenhauer1, now I can really say that this is economics 1.0. That's why I called it "market mechanism kicks in". When there far more demand than supply, then prices go up. It might not be the individual supplier that raises the prices, it may be the buyer that knows that there's a shortage and simply offers to pay a higher price. Markets are a two way street, you know. It's very naive to think that in a shortage situation it's the suppliers that are raising the prices because of greed.ssu

Yes they can bid on prices.. but um, how about first come, first serve? All I'm saying is NOTHING has to go down the way that economic models say it does. It's all micro-behaviors of individuals, not "forces" or "mechanisms". Those are hollow words in a human behavioral analysis. I don't know what you call it when there is a shortage and you let people bid for the highest price.. It could be called being "reasonable" or it could be called "greed". BOTH are value statements. Also, a lot of things in reality DON'T work that way. Outside of things like Ebay, it is the SELLER who sets the price, and anticipates or tests what people are willing to pay based on the conditions. No one is at a grocery store saying that they are going to pay \$100 for toilet paper if you reserve the first 10 packages for them. Rather, whoever gets there, gets the toilet paper.. If the prices rise, it is not due to bidding but due to the willingness for consumers to pay more and possibly slow the demand to allow for increased production.

What makes it a "market mechanism" is the amount of people involved making good (or bad) judgements. That's why we talk about aggregate demand and supply, macroeconomics vs. microeconomics. Not everyone makes good choices. But on average, people are reasonable. And before you say it, yes, there are Animal Spirits as Keynes himself said. Hence many times that market predict things wrong.ssu

Ok, I guess we can agree. But "reasonable" is its own sticky point. One person's "reasonable" is another person's "unethical". Reasonable, is a weasel word, just like "mechanism".. it puts the cart before the horse. It assumes too much on what is the case. I think it reasonable that everyone agrees with what I'm saying.. Is that a good definition? Oh, but we are going to then make "some' definition "the" definition of reasonable... and on and on the circular justification goes.

Now it's likely that the cash given to people won't affect much prices as there is the economy is plunging. For the moment. It's interesting to see what happens.ssu

Yeah, I think we will have a contraction in supply of various goods and services in general as people have less income, and thus less ability to buy anything, thus less demand. Any government money will be used to pay for things like debt or food, necessities to get by, and even that won't get covered. Thus, I don't think it will lead to inflation as people won't be scrambling for more, but simply trying to maintain.

Is the economy anytime in an equilibrium? I see it always going somewhere, up or down...ssu

Yeah agreed. It's what to do about it.. Classical economists would say to ride out any economic difficulties, and Keynesians will say that government should give a boost.
• 2.5k
One person's "reasonable" is another person's "unethical".
In my view an "ethical" price is a marketing ploy and simply hypocrisy.

Or what would you declare an "ethical" price? The price that a supplier has to pay for the resources? The price that a supplier has to pay for resources plus a compensation his or her own "work"? (What on Earth is an "ethical" income for one's work?) Or a price that that pays for the resources, the work, and the investments to produce in the future? You may look at this from the perspective that the "supplier" is being the greedy person here, but I can assure you that the buyer can be the "greedy" one too. We are not forced into slavery now days. Every employer buys our work and we have the option to either take their offer or not to take it. Remember that every person is the "supplier" of his or her own work. And behold, once people are talking about the job market, not the market for vegetables or books, everything seems to suddenly change! Still, it's a market just like with everything else.

Yeah agreed. It's what to do about it.. Classical economists would say to ride out any economic difficulties, and Keynesians will say that government should give a boost.
Now days it's about just who gets the boost. Is it the few rich people or the one's working on the correct market sector, the one's in a labor union that has the ability to pressure the employers? Just what segment of the population get's the benefit? These things are complicated and politics come to the equation always.
• 2
we might also consider the relatively inelastic nature of the supply curve in the short run that in part necessitates the suppliers increase in price, so that the increase in price isn't born of pure calculation but is to a large extent, like most members of the market reactionary.
bold
italic
underline
strike
code
quote
ulist
image
url
mention
reveal