Macroeconomics is the study of economics from an overall point of view. Instead of looking so much at individual people and businesses and their economic decisions, macroeconomics deals with the overall pattern of the economy. To star with, we will look at two main groups of economists: the neo Classical Economists and the Keynesian Economists. Classical economists generally think that the market, on its own, will be able to adjust while Keynesian economists believe that the government must step in to solve problems.
A neoclassical economy is an approach that economics use that relates supply and demand to an individual’s rationality and his or her ability to maximize utility or profit. Neoclassical economists argue that firms buy or rent the factor of production which they operate at the highest possible level of efficiency in order to maximize profits. However, firms have no control over the costs of these factors or of the price at which their finished goods are sold.
Neoclassical economists also argue that consumers maximize utility when the ratio of marginal utility to the purchase price is the same for all the goods and services consumed. To conclude, if the marginal utility per expenditure is lower for one good than for another, it will not be bought. The whole process is governed by the forces of demand and supply. On the other hand, Keynesian economics is a theory of total spending in the economy also called the aggregate demand and its effects on output and inflation.
What Do Classical Economists Believe
Keynesian economics can also be define as an economic theory stating that active government intervention in the marketplace and monetary policy is the best method of ensuring economic growth and stability. According to Keynesian theory, changes in aggregate demand have their greatest short-run effect on real output and employment and not on prices. Keynesian believe that what is true about the short run cannot necessarily be inferred from what must happen in the long run, and we live in the short run.
Keynesian economists also argue that prices and wages, respond slowly to changes in supply and demand, resulting in periodic shortages and surpluses, especially of labor. Moreover, Keynesian typically see unemployment as both too high on average and too variable; also feel certain that periods of recession or depression are economic maladies, not, as in real business cycle theory, efficient market responses to unattractive opportunities.
The original classical school of thought argued that a laissez faire (“hands off”) system, where the government intervened minimally, was the only way to maximize the efficiency of production and ensure freedom in the market place. If there are more profitable business and the freedom to choose it would provide the way to a happy society. The main difference is that in the Keynesian model the consumption is a function of current income, only a real change in the income change the consumption.
However In the neo-classical model it is a function of the present value of all future labor income, plus financial wealth also an announced change in the income change the consumption. What differentiates the old philosophy from the new is their macroeconomic argument. The classical economist Jean Baptiste Say proposed a theory for how economies naturally recover: because the price level falls as spending decreases, businesses could afford to cheaply produce cheaper goods and people could afford them.
This would increase employment and then spending would increase again, causing economic recovery. Were as to Neoclassical economists came around to use the fundamental classical argument (laissez faire) against a group who disproved Say’s law called the Keynesians. During the great depression, then classical economist John Maynard Keynes said that if an economy were to descend in activity so quickly that the inventories of businesses were never sold, then unemployment would never recover because the businesses would never be able to produce more goods without selling their current inventories.
Another difference between neoclassic and Keynesian economists is that neoclassical claimed that increasing government spending would require higher taxes, which, according to the Keynesians themselves, increasing taxes discourages economic growth. There are also some differences that concern fiscal policy; for instance, when government spending (G) permanently increases output increase in both model but consumption (C) and wage (W) fall in a neoclassical model the opposite than in Keynesian models.