Classical and Keynesian Theory (Comparison)

1) What is being compared?

Both theories aim to explain:

• output (Y),
• employment (N),
• price level (P),
• and role of policy.

But they differ on:

• whether markets self-correct quickly,
• whether demand deficiency can persist,
• effectiveness of fiscal/monetary policy.

2) Classical theory: core propositions

2.1 Say’s Law

Often summarized as:

Meaning production generates enough income to purchase output; general glut is unlikely in the long run.

2.2 Full employment as normal outcome

With flexible wages/prices:

• labour market clears,
• involuntary unemployment is not persistent (unemployment is largely voluntary/frictional).

2.3 Saving–Investment equality via interest rate

Classical view:

• Saving (S) and investment (I) are equilibrated by the interest rate $r$.
• If S increases, $r$ falls, encouraging I until S=I.

2.4 Money neutrality (long run)

Changes in money supply affect nominal variables (P, nominal wages) but not real output in the long run.

3) Keynesian theory: core propositions

3.1 Demand deficiency and underemployment equilibrium

Keynes argued:

• wages/prices may be sticky,
• expectations and uncertainty affect investment,
• economy can settle at equilibrium with unemployment.