Chapter 10: Problem 1

How is Keynes's position different from the classical position with respect to wages, prices, and Say's law?

Short Answer

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The main differences between the classical view and Keynes's view are: 1) Keynes rejected Say's Law, asserting that savings could leak out of the economy, whereas classical economists believed in the self-regulating nature of markets where supply creates its own demand, 2) Keynes predicted reducing wages decreases workers' buying power and thus overall demand, while classical economists assumed lowering wages would enable employers to hire more workers, and 3) Keynes stressed the importance of demand in the economy, suggesting that economic recessions can occur from inadequate demand, unlike classical economists who believed markets self-regulate through supply and demand balancing.

Step by step solution

Understanding Say's Law

Say's Law is a classical economic concept which states that the production of goods creates its own demand. In other words, in creating a product, a producer is contributing to the demand for other goods by paying wages, rents and returns on invested capital.

Keynes's Perception on Say's Law

Keynes disagreed with Say's law. He believed that income received by the producers could leak out of the economic circuit through savings. Keynes argued that money saved doesn't necessarily mean it will be invested or spent, contradicting the concept of Say's law where supply creates its own demand.

Exploring the Classical View on Wages and Prices

The classical economic view says that there is a direct correlation between wages and employment. According to this view, if wages are decreased, employers would be able to hire more workers. Similarly, lower prices would stimulate demand.

Keynes on Wages and Prices

Keynes, in contrast, believed that decreasing wages would decrease workers’ buying power, thereby reducing consumer demand. If institutions or individuals hoard the money instead of spending it, overall demand will fall. Keynes noticed the importance of a balanced economy, where both supply and demand are taken into account.

Summarizing the Differences

Keynes had a different perspective than that of the classical economists on wages, prices, and Say's law. The key differences existed in how they viewed the correlation between wages and employment, price and demand, and their understanding of Say's law. Keynes emphasized the importance of aggregate demand in the economy, believing that economic recessions could happen due to inadequate demand, whereas classical economists believed in the self-regulating nature of markets.