Economic Models: Classical, Keynesian, and Synthesis

Posted on Mar 16, 2025 in Economy

Classical Model: The ideas originated with nineteenth-century classical economists, Adam Smith and Ricardo. The main characteristics are:

  1. Predominance of supply over demand: Aimed to explain the economy based on production functions and did not consider application.
  2. Perfect competition in all markets:
    • High number of suppliers and demanders
    • The product is homogeneous
    • Firms are not able to fix the prices of products
    • Perfect information, free entry, and exit of firms
  3. Flexible Pricing: The result is equilibrium in all markets and full employment of resources, making government investment unnecessary.

Keynesian Model:

  1. Domain of demand over supply.
  2. Perfect competition in the goods market.
  3. Possibility of sticky prices in the short term.
  4. Some market factors may be unbalanced, since wages are rigid downwards.
  5. Production imbalance can occur without full employment of resources.

Operation was demonstrated and helped lift the economy of the Great Depression. The term macroeconomics has been applied primarily following the appearance of this model. This model involves:

  • The existence of price rigidities.
  • Money affects the level of production in equilibrium.
  • The state’s role may be necessary in certain circumstances.

Model of Keynesian-Classical Synthesis: Classical in the long run (l/p), Keynesian in the short run (c/p). The model follows the outline of competitive equilibrium in markets for goods, while the assumption of rigidities in prices and wages remains in the short run (c/p). In the graph of supply and demand, macroeconomics is summarized in two curves whose intersection is the overall balance. Aggregate demand in the synthesis model assumes the conventional form with a negative slope. GRAPHICS: Keynes — synthesis / and classical


Features in Different Markets and Aggregate Supply and Demand:

Money Market: Differences: The classical stance is called monetary neutrality, according to which changes in money supply do not affect the variables. For the Keynesians, rigidities and imperfections determine that changes in money supply can cause short-term variations in production, so that money is not neutral.

Labor Market: Differences: For the classical model, nominal wages are fully flexible. For Keynes, wages are rigid downwards because of union bargaining power and workers, but are not rigid on the rise.

Consequences:

  • In the classical model, there is voluntary unemployment because nominal wages are fully flexible, and if someone does not work, it is because they do not want to at the equilibrium wage.
  • In Keynes, as wages are not flexible, there can be involuntary unemployment.

Markets: Demand and Supply in Different Models: The differences between classical and Keynesian models in determining the balance of the economy revolve around the aggregate supply function:

Aggregate Supply (Classical): Fully flexible wages and prices. The salary is adjusted constantly to maintain full employment, with average costs (AC) in the short run (c/p) being constant. If production Y = f (labor and capital), and in the short run (c/p) both are constant, then the total production is constant and therefore independent of the price level, varying due to such flexibility. GRAPHIC: Straight up (OA)

Aggregate Supply (Keynesian): If wages are rigid, there is voluntary unemployment. In the short run (c/p), firms can obtain the quantity they wish to work at the wage, and the average costs do not vary as output increases. If wages are constant, so are the prices. In the long run (l/p), the aggregate supply will be growing because wages will no longer be rigid upward and downward. GRAPHIC: Straight towards the right (OA) from the P (is a very short run (c/p))