1. Answer the following questions about Keynesian vs. Classical view of economic
ID: 1196036 • Letter: 1
Question
1. Answer the following questions about Keynesian vs. Classical view of economics
A. Marginal propensity to consume (MPC) is the slope of the Keynesian AE curve. Using an equation and words, describe the relationship between MPC and the Keynesian spending multiplier. (2 points)
B. Explain why the events of the Great Depression were inconsistent with the classical view of the economy. (4 points)
C. Use the AD/AS model to compare the effects of expansionary fiscal policy at two points on the AS curve: the Keynesian section and full employment. Use graphs, and label everything completely. (4 points)
Explanation / Answer
A. The keynesian spending multiplier is given by:
Keynesian spending multiplier = 1/(1-MPC)
The above expression that that for every one unit increase in spending, the total income(or output) will rise by an amount equivalent to 1/(1-MPC).
There is a positive relationship between MPC and the keynesian spending multiplier. The greater the MPC, the greater the keynesian spending multiplier.
B.
During Great Depression, the world experienced prolonged unemployment and much-below-potential level of output. But as per the classical view, this was highly unlikely as the classical economists always assumed that wages and prices are completely flexible and their flexibiity keeps the economy at the full employment level of output. But Great Depression proved classical economists wrong.
Keynes however came up with an explanation for prolonged unemployment. He was of the view that, contrary to what classical economists assumed, wages and prices are sticky in the short-run and therefore the economy can operate much below full employment in the short run when the economy goes through a spending gut. It is only in the long run that prices and wages are flexible and bring the economy back to full employment level. Keynes' view of sticky wages and prices is presently the mainstream economic view.
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