Keynesian Theory

Neoclassical economists are naturally more reluctant than Keynesians to concede that capitalism as a system might be dysfunctional or that markets might be irrational and inefficient, leading to cycles of boom and bust, mass poverty and unemployment, which happened in the 1930s and is happening again today. One of the main assumptions in the classical model is 'full employed equilibrium' or in other words 'absence of involuntary unemployment.' The classical model assumes that supply of labor and real wage are positively related. Assuming that the wages are flexible, the aggregate supply curve is vertical because a change in the price level does not affect the output. Equilibrium occurs when aggregate demand and aggregate supply intersect. In the absence of regulations, the labor market is always in equilibrium, thus the intersection point determines the real wage, and equilibrium demand and supply. Since the demand and supply are equal in...
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