Neoclassical and Keynesian macroeconomics theories

Neoclassical and Keynesian macroeconomics theories


Arguments and disagreements in the modern economic take the heart of Neoclassical and Keynesian Economics debate. Though macroeconomics is divided into various units, there are some sections that have a common understanding of the way an economy should function and the widespread impact on the present policies.  Neoclassical economics has a distinct faith in the market while allocating resources meant to foster production for the goods and services as well as distributing the incomes evenly. In this kind of economics, production creates the demand expected, and thus there are no instances of overproduction. On the other hand, Keynesian economics is based on the ideology that there would be a possible shortage in the aggregate demands for good and services. Therefore, there is a distinct viewpoint on demand and supply for both Neoclassical and Keynesian economics.

Neoclassical economics has a price for goods as a summary of payment involved such as wages, rent, interests, and profitability for the business. Thus, instances of shortage in the purchasing power are minimal in this kind of economics since despite the massive savings people do, prices of commodities would still adjust downwards to accommodate the financial status. Therefore, any arising attempts to shift the stability of the market ultimately leads to a counterproductive status in the economy.

The market forces and trends ultimately sort an economic crisis such as recessions and depressions due to their various dislocations in the current business cycle. Thus, prices, interests, and wages are adjusted thus attaining employment equilibrium. During Keynesian economics when the aggregate demand falls below the aggregate supply, there is widespread deflation leading to a higher rate of unemployment in the country. Therefore, it is the mandate of the Government to intervene in the economic trends to have a market equilibrium thus restoring the employment rates in the market. Economic thriving is based on the higher rates of employment which stabilizes the economy.

Classical economic theory states that, as the government and individuals balance their budget, there is an economic aspect that needs adherence where deficit budgeting is prohibited. However, Keynesian economics ascertains that deficit in budgets is called to get the economy from their current slump thus increasing the purchasing power through increased investment expenses that through the multiplier effects close the existing deflationary gaps in the marketplace. Therefore, there are different viewpoints on the Neoclassical and Keynesian roles in balancing the economic trends.

Comparison between Neoclassical and Keynesian Economics

Fiscal policy

Keynesian economics can facilitate an expansive economy during recession thus stimulating the economic operations. Shifting economic trends during a recession is always a challenging task that requires technicality in handling. However, the Neoclassical economic direction has not a long-term increase in real product output in the market.  Therefore, this explains the lack of a stimulating structure in the economic trends during fiscal policy.


Both Neoclassical and Keynesian Economics have a significant impact on the unemployment rates in the country over a given time. Keynesian view on unemployment is since it tries to have an emphasizing the supply. Keynesian enthusiasts favor the involvement of the government in the unemployment rate in a country that they are concerned with inflation cases. According to the theory, the primary goal for the employees is to contribute to the economic growth of a state positively.  However, classical economists, on the other hand, have a different view on the unemployment issue in economic trends. In their understanding, unemployment is highly contributed by government involvement with the free markets such as the monopoly within a particular industry. Therefore, through government operations, there are contributions to increased unemployment which alters the economic trends thus interfering with economic equilibrium.

Price and Market forces

Keynesians have a belief that prices are more rigid, and it is the role of the government to maintain their stability. They always want the government to have an influence either directly or indirectly on corporations and people with regards to prices within the specific set rates. On the other hand, classical economists want a free market where everyone is free to locate their levels and supplies. They believe customers desires should be determinants on price rather than government-sponsored policies. Thus, their understanding of cost is that they will always adjust on a short-term basis to the prevailing market demands.

Future Growth of the Economy

The economic view for Neoclassical and Keynesian Economist is different on the future of economic trends. The way they predict the future growth of the economy different between them. Keynesians specialize in short-term based economic challenges while classical economists deal with long-term problems in the marketplace. Keynesians see issues as the most immediate issue that the government should address is an assurance for long-term expansion of the economy. Classists on the other hand concentrate on making a free market adjust to short term problems as they are always based on the long-term challenges. They continuously believe short-term challenges are bumps to slow down the economic growth in the country. Therefore, adjust to the problems would bring a way to avoid an solve them on the way to a long-term economic expansion.  However, whether the Neoclassical or Keynesian Economist is right on their viewpoints, they cannot be determined with certainty.

Government borrowing

The classical assessment suggests that government borrowings should be regulated to a minimal rate to enhance a balanced budget since they are not necessary. Lowered taxes will increase efficiency in the market. They argue that there are no substantial benefits from increased government spending. On the other hand, Keynesian suggests that government borrowing is essential and helps in increasing the aggregate demand. Therefore, they support increased lending in the government despite considering the negative impact borrowing brings to the economy.

Government spending

The Keynesian model suggests that there are higher government interventions in different economic trends such as in a recession where government spending should be brought into an offset to enhance a private sector investment in the economy. Additionally, the model supported the New Deal Program of the 1930s. On the other hand, the Classical model is referred to as laissez-faire as there is little need for government interventions n the prevailing economic trends. Therefore, both Keynesian and Classical models have a diverging view on government spending which brings different shifts to economic trends.

Supply-side policy

On the viewpoint of classical economists, it is essential to enable a free market for existing which involves a reduction on the power of trade unions and activists in the economy thus preventing wage inflexibility. Through classical economists, there has been supply-side economics that emphasizes the roles of supply-side policies that are used promoting long-term economic expansion. The Keynesian view does not reject supply-side policies as they are said to always be enough for the economic functioning in that, there are instances where supply-side polices cannot handle the fundamental problems on lack of demand.

Fig 1.1

As shown in Fig 1.1 above, the Keynesian view of the long-term aggregate supply, wages are sticky on a downward level, there is an adverse multiplier effect where once the aggregate demand falls spending falls.

Nature of Interest

According to the classical economists’ view, interest is a non-monetary phenomenon while the theory of interests is real. This comes with the questioning on the nature of interests involved in both Neoclassical and Keynesian macroeconomics theories. For Keynesian model, interest is purely based on monetary aspects on the theory of interests is a monetary theory of interest. While determining the rate of interest in the classical theory model, the rate of interest is defined based on the equality between the supply of capital and demand. However, with Keynesian theory, the rate of interest depends on the fairness of demand between the money supply and demand. Therefore, between the two models, there are distinct differences when it comes to the prevailing nature and rate of interests in the economy.

Demand and Supply Side

Regarding the Keynesian theory, demand for monetary gains is a demand for liquidity. Thus, the theory is a technique that leads to the increased holding of money in cash. As more cash is held, there is reduced money in circulation within the economy. Demand for precautionary motives and transactions is the dominant task for the interest-inelastic and income, while the economic demand for speculative motives has an adverse function to the rate of interests return. Thus, the demand for money is elastic at a minimum level of the economic rate of interests called the liquidity trap. On the contrary, the classical theory of interests states that demands for capital area demand created by investment thus influencing marginal productivity of the available capital. Therefore, demand related to capital is an adverse function on the interest rate. Additionally, in classical theory, capital supply originates from savings that depend on the ability and willingness to save. Thus, capital supply is a positive task mandated to interest rates. On the other hand, the Keynesian expresses that the money supply is fixed and controlled by the monetary authority in the country’s economic policies.

Saving-Investment Equality

As stated by the Keynes, income is the equilibrating factor for savings and investments. This excluded the available rate of interests. Being a purely financial phenomenon, the rate of interests achieves equality for both the supplies of money and demand. Classical economists value rate of interest as an equilibrating factor for investment and savings. Therefore, there is an inverse difference between classical and Keynesian economists.