Pranav Vikram Shriram 1264456 Introduction to Economics BS1547

Introduction to Economics Macroeconomics Assignment- 1 Neo-Classical and Keynesian “The study of how society, and those in society allocate scarce and hence valuable resources between competing uses can be defined as Economics”(Jones, 2013) which was founded by Adam Smith in 1776. “The field of Economics that deals with the aggregate economy and changes in its level of unemployment, national income, growth rate, GDP, inflation and price level is called Macroeconomics.”(www.investopedia.com) As economics developed two distinct approaches were seen to immerge the Neo Classical which stated that Macroeconomics = ∑Microeconomics and the Keynesian which stated the opposite. Both these approaches are still followed in the managing of the present world Economies. Figure 1.

As seen above, Neo classical approach lasted several years before the Great Depression, but was revived once again after the period of stagflation when the Keynesian approach failed to improve the economic condition. The Neo Classists approach influenced by Adam Smith and others with reference to the ‘invisible hand theory’ (Jones, 2013) stated that the “market is best left alone and that it will adjust and clear itself and hence finding its own macro-equilibrium.” (Jones, 2013) Keynes suggested that this is not realistic approach and that “government intervention is needed for the market to reach its macro-equilibrium.” (Jones, 2013) The Neo Classical approach towards Economic production states that since “economic agents are rational in their thinking” (Jones, 2013) they will use their resources in an organized manner making “the production process more efficient, hence no overproduction.” (Jones,2013). This is also seen in the approach to markets from “Say’s law of a market:∑piSi = ∑piDi.” (Jones, 2013) According to Neo supply derives demand, and “since they are price takers as long as prices are flexible, the market will clear.” (Jones, 2013) “The Marshallian Market Clearing Mechanism helps explain that if ever there is over supply or excess demand the price will adjust quickly and adjust before the quantity and capital
Page 2 of 9

Pranav Vikram Shriram 1264456 Introduction to Economics BS1547

stock levels bringing the market back to its macro-equilibrium.” (Jones, 2013) The diagram below reflects this clearing mechanism. Supply shifts from AS to AS1, the price decreases from P1 to P2 and the quantity moves from Q1 to Q2, showing the price adjustment to arrive at new macro-equilibrium is obtained. Figure 2.

Reference: (Jones, 2013) “The approach towards firms/entrepreneurs and households is that they want to maximize their profits and the utility of goods and services for their welfare respectively.” (Jones, 2013) On the contrary, Keynes approach to Economic Production is that economics agents are irrational and hence are inefficient in their management causing overproduction. The difference seen in the market approach is that “Keynes argues that demand derives supply and that prices are inflexible.” (Jones, 2013) This again takes us to “The Marshallian Market Clearing concept expects in reverse order that that price adjusts after the quantity and capital stock levels,” (Jones, 2013) which shows the price is very slow to adjust as seen in the graph below. As seen AS Y2