Question

3) Compare the Classical school versus Keynesian school a. Market failure tends to be the focus of the Keynesian school and government failure the focus of the classical school. Explain b. Link your discussion to the debate between John Maynard Keynes and Fredrick Von Hayek in the Commanding Heights video.

Answer 1

a) Classical school states that the economy is self regulating, Economy is capable of achieving the natural level of GDP when the resources are fully employed. It might be that GDP falls below the natural level or exceed it other times because of government failure, however self adjustment mechanisms ensure that the market system will bring the economy back to the natural level. Interest rate flexibility keeps the money market in equilibrium, wage rate flexibility also keeps the labor market in equilibrium. They think that unemployment comes from government intervention and government should have a balanced budget.

Keynesian school emphasizes that market failure occurs when it is left to its own mechanism. Which is why government should intervene, when there is a recession and people aren't spending, government should spend and create jobs. Governments should borrow as it increases aggregate demand in the economy. They are more concerned about jobs and not about inflation.

b) Keynes debates that government spending saves the economy. However Hayek stated that too much public debt creates friction and impacts the economy a great deal than private debt does. This increase in debt might spiral down to job losses. He further argued that the market would become distorted if this stimulus provided by government is removed as people would be making goods which didn't have any demand.