Keynesian Theory
Overview
Keynes believed that aggregate demand was the factor that accounted for economic downturns. He challenged the assumptions of the classical model,
especially in the
short run. As Keynes would put it,
"In the long run, we are all dead."
Differences with the Classical Model
-
Investment Fluctuations
- Keynes believed that fluctuations in aggregate demand were the primary culprit in economic downturns.
He provided an in depth analysis of aggregate demand, breaking it down into a set of
National Accounts.
Keynes believed that the components of aggregate demand were generally fairly stable, with the exception of
investment demand.
- Sticky Wages
- Keynes asserted that wages are sticky on the downside. That is, employers do not like to lower an employees wage, and
employees are not likely to take wage reductions lightly. This means that if aggregate demand goes down, wages will not easily adjust
downwards with the rest of the price level. This implies that employers will have to lay off some of their workers, causing a further
reduction in aggregate demand.
Policy Responses
The typical policy response in a Keynesian framework is to try to find some way to prop up demand. This can be done in various ways.
