Introduction
There is a long standing debate in .Economics between the classical school of macroeconomics and the Keynesian school of Macroeconomics. While the classicalists school believes in a laissez faire or free market economy the Keynesian school proposes government intervention in times of recession, inflation or such other macroeconomic disbalance in the economy. In this paper we are going to present the major differences in the Classical and Keynesian school of macroeconomics in terms of aggregate demand and supply and in terms of the impact on inflation and unemployment.
Aggregate Demand and Supply
The classical model is a supply side model. The proponents of the classical model believe that ‘supply creates its own demand’ . The production function determines the demand for labor and the supply of labor is determined by the able bodied people in the economy. The interaction between demand and supply of labor determines the wages. The production process itself creates employment and thus generates income which creates demand for the output produced. Thus production technology, labor supply, efficiency of labor and such other supply side factors influence gross output in the economy. The classical economists believe that the economy requires minimum government intervention. The natural movement of demand and supply forces will automatically adjust to maintain full employment in the economy.
Thus in the classical model the long run aggregate supply is fixed at the full employment level. It is vertical straight line at the full employment level of output. As the aggregate demand increases the demand curve shifts upward leading to a rise in the price level without any effect on the gross output.
The Keynesian school is on the other extreme which proposes a demand side model. The model believes that the economy can be in equilibrium at a lower level of output than the full employment level. It is the changes in the aggregate demand that acts as a driving force to influence the gross output The supply curve is upward rising and ultimately becomes vertical at the full employment level of output. Suppose the economy is at equilibrium below the full employment level. An increase in the aggregate demand will lead to a rightward shift in the demand curve. The increased prices will induce more production thereby increasing the gross output . Thus aggregate demand is a driving force in the economy.
Inflation and Unemployment
The trade- off between inflation and unemployment as represented by the Phillips curve is an outcome of Keynesian macroeconomics. An increase in aggregate demand will lead to rise in the prices. The higher price will induce more production. The higher level of production will create more jobs. Thus unemployment will be reduced. Thus the reduction of unemployment through the increase in aggregate demand is accompanied by a corresponding rise in inflation. Thus there is a negative relationship between unemployment and inflation. If we want to reduce unemployment we have to tolerate some amount of inflation.
The classicalists on the other hand strongly believe that the trade-off between inflation and unemployment does not exist in the long run. According to the classical theory the unemployment will tend to settle at the natural rate in the long-run. This natural rate of unemployment is determined by the full employment level of output. Any measure to reduce the unemployment from the natural rate will be successful only for a short period. In the long run the wages and prices will adjust to resptre the unemployment to the natural rate. Thus the classical school opies that the long run Phillips curve is a vertical straight line.
References
Ackley, G. (1978). Macroeconomics: Rheory and Policy. Macmillan.
Levacic, R., & Rebbman, A. (1982). Macroeconomics: An introduction to Keynesian-neoclassical Controversies. Macmillan.
Mankiw, G. (2013). Macroeconomics. Macmillan.
