Keynesian Economics: Definition, History, Summary & Theory

Instructor: Jennifer Francis

Jennifer has a Masters Degree in Business Administration and pursuing a Doctoral degree. She has 14 years of experience as a classroom teacher, and several years in both retail and manufacturing.

This lesson will present the theory of Keynesian economics, its origination and development. It will also connect Keynesian economics with other economic concepts.

Keynesian Economics

You might have heard stories of the great depression which occurred in the 1930s. Have you ever wondered how we were able to climb out of that pitiful time in our history? The theory of Keynesian economics is one that believes in the idea that total spending, referred to as aggregate demand, is really important for keeping an economy thriving. The spending referred to includes spending by individuals, families, businesses, and governments.

This was in stark opposition to the classical view of economics. Prior to the 1930s, the classical economists like Adam Smith, David Ricardo, and Jean-Baptiste Say, along with the rest of the world, believed in the idea that supply of goods and services created its own demand. In this school of thought, an increase in total production would spawn sufficient earnings to buy all of the output produced. An important assumption of the classical theory was that flexible interest rates would always sustain market equilibrium. The primary principle of classical economics was that the economy is self-regulating, through full use of all available resources.

John Maynard Keynes

The theory of Keynesian economics was first touted by the British economist John Maynard Keynes, who believed that government spending through the employment of long unemployed individuals, would be the trick to bringing the world economies out of the depression. He believed that the spending would not be for its sake, but to build basic infrastructure, and provide vital social services to the public.

Keynes believed that this move would mean that previously unemployed persons would now have money to spend, which in turn would pay other workers, who are then able to spend, paying even other employees. This increase in aggregate demand would mean an end to the depression. This was in 1933, and by 1939 the depression was over. Many believe that John Maynard Keynes' theory was largely responsible for bringing an end to the great depression.

Keynesian Economics in Action

Here's a hypothetical example to illustrate this further:

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