Neoclassical and Keynesian Economics - Coursework Example

Running Head: Neoclassical and Keynesian Economics Neoclassical and Keynesian Economics Customer’s Name: Institution: Customer’s Course Tutor’s Name 27th March, 2013. Introduction With the ever emerging process of economic integration that is evident around the globe as well as the drift of globalization, international trade is seen to play an important role when it comes to aspects that are related to economic as well to economic growth. There seem to be two main ideas when it comes to economics, one of them is the Keynesian view and it places a lot of value on the believe that the government regulation is essential in all the trading activities and the other is the neo-classical view which tend to favor aspects that are related to the protection and trade liberalization (Althaus, Bridgman & Davis, 2013). In this article I will set out to discuss the differences that exist between the Keynesian/ welfare state approach and the neoclassical/new right policies for the economy. In doing so, I will illustrate the differences based on at least one policy area for example health, welfare and education. The last section will be a discussion of the strengths and weaknesses of the approaches in relation to the policy area that have been selected. Differences between neoclassical and Keynesian view of economics Keynes theory commonly referred to others as a revolution which had occurred to economics. Irrespective of this, his theory received a lot of criticism and this eventually led to the emergence of neoclassical synthesis which was termed as a group of theories that reunited previous economist and Keynes view and thus there was a formulation of a creative prospect to economics (Arnold, 2002). A neoclassical economy is termed as an approach that is used by the economists and it mainly relates to the demand and supply to an individual prudence and their capability to maximize profit or utility. While the neoclassical economists argue that organizations rents or buy the factors of production and they tend to use it at the utmost probable level of efficiency so as to attract the required level of profits (Beresford, 2000). The firms do not have any form of control on the price that is charged for their manufactured goods. These economists also argue that customers can be able to maximize the utility of a product in instances when the ratio of the marginal utility of buying pricing is similar for all the services and goods that are being consumed. Thus in instances when the marginal usefulness per expenditure is lesser as compared to the marginal usefulness of another the product is likely to purchase less (Blanchard, 2009). Thus the whole process tends to govern by both the forces of supply and demand. Contrary, Keynesian economics are termed as a theory that is bestowed on the total spending in an economy and it can also be termed as being the aggregate demand and it affects both the output and inflation in the country (Colebatch, 2006). Keynesian economics can also be termed as being the economic theory that states that there is an active government involvement in the market and the monetary policy seems to be the most appropriate method for ensuring that economic growth and stability is attained, based on this theory, the changes in aggregate demand tend to have a short term effect on the employment levels and productivity of the firm and not on price (Fenna, 1998). Keynesian was of the belief that what is experienced in short term cannot be inferred to happen in the long term. One of the major differences between neoclassical and Keynesian is based on the price stickiness. The disagreement that exists between the neoclassical and Keynesian economists is related to how wage and price adjust within a short period of time. Based on this the neoclassical economists attain their macroeconomic theories based on the assumption that both prices and wages are easily flexible. They are of the belief that prices have the power to clear markets that is they are able to balance the demand and supply based on their easily adjustable aspect. The Keynesian economists on the other hand believe that the market clearing models cannot be used to explain a short period of economic fluctuations and so they are of the view that the society needs to embrace models that have sticky wages and prices, the Keynesian economists rely in the stickiness so as to be able to explain why some individuals tend to be involuntary unemployment and also why the monetary policies have a very noteworthy impact in the economic activity of a country. The other major difference between the two is more related to the income distribution. This controversy can be rooted back to when there was a clash based on the vision on what could possibly make an acceptable theory when it comes to the distribution of income. While the Keynesian model was of the view that distribution of income could be well clarified by the power differences that existed between the capitalists and the workers. The neoclassical were of the view that the best explanation would be developed and derived from a market theory in relation to factor prices. Strengths and weaknesses of neoclassical view of economics One of the major strengths of the neoclassical economics is that it assists a lot when it comes to explaining how the prices that are charged on an item and the specific quantities that are produced are arrived upon in the economy. Another major strength of neoclassical economics is that there are lower taxes. Neoclassical economics is solely based on the idea of lowering the marginal rates of tax. Theorist under this category argues that high marginal rates tend to penalize investment and work since the taxes are raised. Lower taxes on the other hand offer a very adequate incentive for people to be able to earn more and to be able to save the additional money that they earn. For them lower taxes basically means that they have a greater level of freedom in that they are able to earn more and at the same time invest more and thus they will eventually prosper (Romer, 2000). The other strength is that neoclassical economics tend to spur economic growth. According to neoclassical theorists, lower marginal rates tend to symbolize a strategy for the long-term economic growth. Since it is highly believed that the higher marginal level put off additional work as well as effort, the cutting of the marginal taxes offers the business owners and the workers with an incentive and they are able to work for longer hours and thus they are able to earn additional income which would eventually be taxed at lower rates. When the increased level of work that is performed by an individual is coupled with the expanded investment there is a greater level of economic output as well as high level of gross domestic product (Snowdon & Vane, 2005). Weaknesses of neoclassical economics One of the major weaknesses of the neoclassical economics is based on the fact that the mathematization of economics. The theory greatly ignores the irrationality that exists in life and thus it tries to clutch an inestimable selection of economic phenomena in dry balanced schemes and ideas. The other major weakness of neoclassical economics is that there tends to be income inequality. Opponents of the neoclassical economics assert that the neoclassical economics tend to increase the disparity that exists between the poor and the rich in the society. Neoclassical econo9mcis greatly supports the fact that there is lowering of income taxes as well as the capital gains from taxes (Snowdon & Vane, 1997). Therefore the primary beneficiaries of such changes tend to be richer and they are the ones who have the highest incomes. Though the policies act as a measure to reduce unemployment or at times to benefit the majority of the people in the society, the people in the upper class are the ones who receive the greatest number of benefits as compared to the lower class. The other major weakness of neoclassical economics is more related to deficits. An early claim that was made by the supporters of the neoclassical theories is that higher tax rates do not at all times lead to an increase in the tax returns. They asserted that by lowering the tax rate there would be a tremendous increase on the amount of money that has been contributed as taxes since the lower rates of taxes would eventually lead to economic growth. It was believed that the government would take a small pie but ultimately the pie would be bigger than expected. In practice the neoclassical economics applications in a way resulted in a notable decrease in the amount of government revenue (Stewart, 1999). A decrease in tax revenue that is generated mainly leads to deficits or at times it also leads to a reduction in terms of the services that the government offers to its citizens. The other weakness is that besides lowering the taxes, another belief of the neoclassical economics is that reduced regulation can spur growth. It is true that lower regulations and rules can lead to higher gross domestic and higher profits but with certain hidden costs of deregulation. For example in instances where a government can reduce the emissions regulations on the power plants, the power plants will tend to make more money and thus there will be a benefit to the citizens since electricity will be cheaper for them (Stewart, 1999). These kinds of benefit do not take a favorable consideration of aspects for example in the health care facilities, for example the medical costs of the individuals who may ail from lung cancer and from asthma will tend to lose when they feel sick. Thus while deregulation may at times make the economy grow, it may also lead to a reduced health as well as the standard of living of the people The last weakness is related to the flaws that exist in trickle down theory. While neoclassical economics states that the wealthiest people in the society will take advantage of the opportunity that have been given by the lower tax rates to be able to purchase more items, start investments and ensure that they invest more, thus there will be a growth in the economy. Though this may be true, economic growth seems not to be growing uniformly (Rabin & Stevens, 2002). For example if a greater number of people purchase cars, the factory workers may benefit, but the largest amount of the money will benefit those at the top that are the managers, executives as well as the shareholders of the company. Strengths of Keynesian economics Keynesian economics tend to have both strengths and weaknesses. One of the major strengths of Keynesian economics relates to the lesser nominal interest rates. Keynesian economics tend to advocate for a lower rate of nominal rates so as to spur investment. Most commercial banks are expected to pay certain nominal rates when they are borrowing from the central banks. When these rates are lower, commercial banks are able to borrow more money so as to lend to the investors. Similarly, the investors are also willing to borrow the money from the commercial banks in instances when the cost of investment is lowered. Investors make use of the borrowed money to start up new business ventures, expand the already existing businesses. It is commonly believed that the spending by the borrowers ultimately leads to a renewed level of growth in the economy (Minsky, 2008). Another major strength of Keynesian economics is that it leads to improvement in infrastructure. An increase in government spending in infrastructure development is as a result of a feature of the demand side economic rules. Through improvements in infrastructure, a country is provided with expanded highways, updated bridges as well as repaired roads, for example during the great depression which occurred in 1930s, the government spends a lot of funds on developing infrastructure and one of the structures can be still present is the Hoover Dam (McClelland & Smyth, 2009). Expanded as well as improved infrastructures create ways for new business ventures and ideas and at the same time ensure that there is an expansion of the already existing businesses which help to achieve the anticipated economic bounce back. The other strength of Keynesian economics is that it assists a lot in the creation of jobs. Job creation is seen as being the motivating factor when it comes to lowering the interest rates and also spending of money for the benefit of the public. The Keynesian economies assert that spending and earning of the paychecks need to be upheld with the same level of significance as the fuel economic growth. Clothiers, restaurants, landlords and the food producers tend to benefit directly from the spent checks (Maddison & Denniss, 2009). The last strength is that it tends to address the needs of the economy. The government at times uses targeted cuts in tax so as to encourage advancement in technology, through this they are able to sharpen the nation’s competitive position and at the same time encourage economic growth. Some entrepreneurs and businessmen may increase their level of spending or at times shift their spending to correlated areas of demand for them to qualify for tax cuts (Krugman, 2009). Weaknesses of Keynesian economics One of the major weaknesses of Keynesian economics is related to inflation. It is commonly seen as the leading weaknesses when it comes to the demand side economics. The Keynesian economies assert that the market economy cannot be able to ensure that there is sufficient and adequate demand and this means that the society will not be able to utilize its production capacity (Krugman, 2009). A Keynesian economy requires that the government to make certain that there is sufficient and adequate demand and full employment. The opponents of the Keynesian approach argue that an increase in government spending will ultimately lead to excessive spur on the economy and thus there would be an increase in price for the businesses and the consumers. This would in turn force banks such as the central bank to boost their interest rates and this would hamper the capability of firms when it comes to borrowing money. Another major weakness of Keynesian economics is that there tend to budget deficits. During economic slowdown and also during recessions, a reduction in activity mainly leads to decline in output. The government spending in the aim of compensation for the decline that has been experienced in aggregate demand is usually financed through borrowing, this in turns tends to increase the deficit of the government and thus there is a rise in the national debt (King, 2002). The increase in government makes some funds to be diverted so as to repay the debt and thus the government is left with little amount of funds to deal with various productive activities such as building of infrastructure and education. The last weakness is of Keynesian economics is related to policy lags. Keynesian economics demand that the government to take necessary action to ensure that there is a stable aggregate demand. Excessive demand is said to lead to inflation and also to insufficient demand which ultimately leads to higher rates of unemployment this Keynesian economy requires that the government to take various actions to ensure that the people spend less when there is a healthy economy and also they spend more when the economy is not doing well (Keynes, 2008). It is highly believed that the policy making process seems to be responsible for the delays that are experienced in the implementation and adoption of certain policy measures. There also seems to be an additional lag linking the change in economic policy of the government and the effect of the policy on the economy (Hutton & Giddens, 2000). Conclusion Over the last decade, neoclassical economists have received a lot of attention. There have also been numerous efforts aimed at mixing the neoclassical economics and Keynesian economics. However, neoclassical economy seems to be attacked since it does not consider the human behavior and it also forgets that real people seem to be different from the man that have been created in the theory. Both Keynesian and neoclassical theories are still debated in the current economy and the awkward fresh recession restarted the debate. References Althaus, C., Bridgman, P., & Davis, G. (2013). The Australian policy handbook (5th edn.). Sydney: Allen & Unwin. Arnold L, G. (2002). Business Cycle Theory. New York: Oxford University Press. Beresford, Q. (2000). Governments, markets and globalization: Australian public policy in context. Sydney: Allen & Unwin. Blanchard, O, (2009). Macroeconomics. New Jersey: Pearson Education Inc. Colebatch, H.K. (Ed) (2006). Beyond the policy cycle: The policy process in Australia. Sydney: Allen & Unwin. Fenna, A. (1998). Introduction to Australian public policy. Melbourne: Addison Wesley. Hutton, W., & Giddens, A. (Eds) (2000). 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