Question

Compare and contrast classical economic theory with Keynesian economic theory. Explain how they both can be "correct."

Answer 1

Classical Theory.   

It is based on the principal supply creates its own demand.

It signifies that saving and investments are directly related.

Prices are flexible.

It's a long run view, signifying long run solution.

It assumes that there is no intervention by the government ( laissez faire approach and market is perfect).

It considers full employment as normal where equilibrium exisits.

It assumes money is only used as medium of exchange.

Keynesian Theory

It signifies that demand creates its own supply.

Saving and investment are not directly related all the time.

Prices are rigid in short run due to sticky wages.

It applies in short run and considers that in long run no one is alive

It assumes that intervention by government is necessary and needed for efficiency.

It considers full employment never exist.

It considers money as medium of exchange as well as store if value.

In the long run both classical and Keynesian approch is similar because prices are flexible, government intervention is not needed, unemployment donot exist. So Keynesian and classical approach converge to some extent in long term.