218 Putting It Together: Keynesian and Neoclassical Economics

Summary

The goal of this module was to teach you to understand the Neoclassical and Keynesian perspectives on macro theory, to identify their strengths and weaknesses, and to be able to apply each one to appropriate contexts. You learned how to:

• Understand the tenets of Neoclassical Economics
• Understand the tenets of Keynesian Economics
• Apply the tenets through the aggregate supply and demand model
• Compare and contrast the circumstances under which it makes sense to apply the Keynesian and Neoclassical perspectives

Examples

Let’s return to the questions posed in the Why it Matters feature. We have seen that both schools of thought believe economic growth to be the result of increases in the supply of labor, increases the supply of capital and improvements in technology. This can be shown by a rightward shift in the long run aggregate supply curve.

Keynesians believe that business cycles are caused primarily by shifts in the aggregate demand curve, but also by shifts in the short run aggregate supply curve. Neoclassicals believe that business cycles are caused by shifts in the long run aggregate supply curve.

Keynesians believe that unemployment occurs when aggregate demand decreases, and inflation occurs when aggregate demand increases. Neoclassicals believe that aggregate demand only affects inflation, in a positive relationship—higher aggregate demand yields higher inflation while lower aggregate demand yields lower inflation.

While there are economists who consider themselves exclusively Keynesian or exclusively Neoclassical, the majority believe that both perspectives have something to offer. Keynesian thinking makes sense over periods of time too short for wages and prices to adjust fully to demand or supply shocks. Neoclassical thinking makes sense over longer periods of time. Thus, Keynesian thinking is usually applied to understanding business cycles and Neoclassical thinking to economic growth.