Question 2 a. Illustrate and critically discuss as to why Keynes rejected classical views. Keynes rejection on classical views can be illustrate and discussed through Keynesian theory. Keynes argued with classical views that relying on markets to get to full employment was not a good idea. He believed that the economy could settle at any equilibrium and that there would not be automatic changes in markets to correct this situation. The main Keynesian theories used to justify this view were: • The labour market • The market for loanable funds (money market) • The Multiplier • Keynesian inflation theory (http://interzone.com/~cheung/SUM.dir/econthyk1.html) The labour market Keynes didn't have the same confidence in the labour market as Classical economists. He argued that wages would be 'sticky downwards'. In other words workers would not be happy about taking wage cuts and would resist this. This would mean that wages would not necessarily fall enough to clear the market and unemployment would linger. (Sloman and Norris 2002, p. 391) Figure 4 : The labour market Source: (http://interzone.com/~cheung/SUM.dir/econthyk1.html) When the demand for labour falls from D1 to D2 (maybe due to the onset of a recession),the wage rate should fall, so that the market clears. However, Keynes argued that because wages were sticky downwards, this would not happen and unemployment of ab would persist. This unemployment he termed demand deficient unemployment. The market for loanable funds (money market) Classical economists were of the view that savings would need to be increased to provide more funds for investment. Keynes disputed this assumption once again because he had less faith in markets as the economics 'miracle cure'. He argued that any increase in savings would mean that people spent less. This would mean a decrease in aggregate demand. This would just make things worse and firms would be even less inclined to invest because they would find the demand for their products decreasing. He felt that investment depended much more on business expectations. (Sloman and Norris 2002, p. 392) The Multiplier Any increase in aggregate demand in the economy would result, according to Keynes, in an even bigger increase in National Income. This process came about because any increase in demand would lead to more people being employed.
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