Economy Models: Classical Vs Keynesian

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  • 0:01 Economic Models
  • 0:27 Classical Model
  • 1:41 Keynesian Model
  • 3:31 Differences
  • 4:35 Lesson Summary
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Lesson Transcript
Instructor: Christopher Sailus

Chris has an M.A. in history and taught university and high school history.

In this lesson, we explore two important models that economists use to decipher capitalist economies and discuss when each is best used to describe the economy.

Economic Models

Vanilla or chocolate? Reading a book or watching TV? Driving to the store or walking? These are just some of the choices many of us have to make day to day. All of these choices have their merits of course; for example, walking to the store is healthier and better for the environment than driving, but driving there will probably get you there and home quicker. In economics, we also have choices, and today we'll be taking a look at two different economic models: the classical model and the Keynesian model.

Classical Model

The ideas that made up the classical model of economics came about during the Enlightenment, a period in Europe from the late 17th through the early 19th century when logic and reason were championed. It was the first time people really began to think about the larger economy, rather than simply worrying about the market down the street or the money in their pockets. Men like Adam Smith, Thomas Malthus and John Stuart Mill all contributed ideas to what became the classical model, though there really isn't one true founder.

Basically, the classical model states that prices go up and down in the marketplace and adjust according to the overall health of the market. If times are bad and people do not have a lot of money to spend, prices will fall over time to adjust to that reality. Likewise, when times are good and people have more money to spend, prices will rise over time to account for that.

The economy, according to classical economists, is self-correcting and needs no help in regulating itself when prices fluctuate. Importantly, the classical model assumes full employment; that is, that everyone who wants to work has a job. With this assumption in mind, prices become extremely flexible. The more money in the economy, the higher prices can be; with less money, lower prices. It seems almost natural.

Keynesian Model

Unlike the classical model, the Keynesian model was largely the work of one man and one time period: John Maynard Keynes and the Great Depression. Keynes was an economist who lived through the Great Depression; he watched the stock market failure in 1929 and the calamitous events of the 1930s when 25% of the United States was unemployed - that's one out of every four men!

Keynes noticed that the classical model didn't really hold a lot of weight when its key assumption - full employment - wasn't realized. After all, the economy may have been self-regulating at full employment, but what did it do when a quarter of the country wanted to work but couldn't find a job? The Keynesian model stated that the economy can be below or above its potential, meaning the economy is not always at full employment, as the classical model assumes.

Keynes realized that unemployment was so high because many businesses were folding, and the businesses that did remain would eventually have to sell their goods at prices so low that they would never make a profit and possibly fold themselves. The economy may truly, as classical economists claimed, be self-correcting, but the correction may take far longer than anticipated. He worried that if an economy functioned at below its full employment and potential for too long, production and wealth levels could get stuck there and never return to pre-Depression levels. In order to avoid this, the economy needed a bit of a jump-start.

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