Assane SECK University of Ziguinchor

UFR : Economics and Socials Sciences

Département : Economics and Management

Level : 3 License
Option : Economic and Social Analysizs

Module : English

Subject : Classical model and Keynesian criticizm

Presented by : Moussa DIENG, Djadjia NGOM & Moussa Saliou

SAKHO

Professor : Dr SAMB
College year 2019/2020

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 PLAN

INTRODUCTION

I. The Classical Model

1. Law Of outlets
2. Quantitative theory money
3. Market Self-regulation
II. The Keynesian criticism
1. Principle of effective demand
2. Principle of preference of liquidity
3. State intervention

CONCLUSION

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 INTRODUCTION
The classical model was popular before the great depression. It say that the ecoonomy is very
free-flowing, and prices and wage freely adjust to the ups and downs of demand over time. In
other words, when times are good, wages and prices quickly go up and when times are bad,
wages and prices freely adjust downward the major assumption of this model is that the
economy is always at full employment.a second model is called the keynesian model. As i
said before the model came about as a result of the great depression.economist johnmaynard
keynes observed that the economy is not always at full employment. In other woods the
economy can be below or above is potential. During the great depression unemployment was
widespread, many busnesses failed and the economy was operating at much less than is
potential.

I. The classical model

In macroeconomics, it has been customary since Keynes to group together under the name of
"classical" theory the current of thought which goes from Adam Smith (Wealth of Nations,
1776), Jean Baptise Say(Treaty of political economy, 1803), 1803) and David Ricardo
(Principles of political economy and taxation, 1817) until Alfred Marshall.
Thus, three principles are at the base of this classical theory:
the law of outlets, the quantitative theory of money and the self-regulation of the market.
1. Law of outlets
The law of outlets is a theory developed by economist Jean-Baptiste Say (1767-1832) according
to which the producer creates demand by offering his products, thus offering an outlet for other
goods for the amount of his value. If the producer offers his production, it is in order to be able,
with the income he derives from it, to acquire other products, thus creating outlets for other
producers, money being only an intermediary in trade. According to this law, there could be no
crises of overproduction.

« Since each of us can only buy the products of others with our own products; since the value
that we can buy is equal to the value that we can produce, men will buy all the more the more
they produce. There this other conclusion which you refuse to admit, that if certain commodities
do not sell, it is because others do not occur; and that it is the production alone which opens
outlets for the products. » Jean-Baptiste Say - Letter to Malthus on political economy and the
stagnation of trade

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 2. The quantitative theory of money

The quantitative theory of money postulates a direct link between the quantity of money in
circulation and the price level. According to this approach, monetary stimulus does not have
lasting beneficial effects on the economy, it will only generate inflation.

Distant origins

From the Renaissance, Nicolas Copernicus and Jean Boding put in relation the link between the
quantity of money in circulation and the evolution of prices. Indeed, the arrival of gold
following the colonization of America leads to inflationary surges, mainly in Spain.

In the 19th century, the quantitative theory of money was developed in particular by David
Ricardo. Karl Marx, however opposed on many points to Ricardo's thought, is also a supporter
of the quantitative theory of money. It can be summed up as follows: a change in the money
supply results in an increase in prices.

A little bit of technique.

The equation at the base of the quantitative theory of money is due to Irving Fischer, an
American economist of the beginning of the 20th century. It comes in the form:

M×V=P×Y

Where M is the quantity of money in circulation, V the speed of circulation of money (number
of transactions carried out), P the price level and Y the volume of production (in other words
the GDP).

This equation is an accounting identity, not a theory in itself. However, supporters of the
quantitative theory of money consider that V is fixed and that Y is independent of the quantity
of money in circulation. In this case, a change in the money supply is automatically reflected in
a change in the price level. In other words, an increase in the quantity of money automatically
creates inflation.

The quantitative theory of money will be defended in the second half of the 20th century by a
current of thought sometimes called monetarist, of which Milton Friedman was one of the main
representatives. According to Friedman, "Inflation is always and everywhere a monetary
phenomenon in the sense that it is and can only be generated by an increase in the quantity of
money faster than that of production."

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 3. Market self-regulation

Smith's "invisible hand" metaphor is interpreted to mean that by allowing individuals to act
in their own best interests, general well-being is assured. The pursuit of self-interest leads
to exchange, which leads to specialization and therefore to general prosperity.

Since the market is an effective instrument, state intervention is therefore unnecessary in

the economy.The role of the state is to maintain public order and carry out sovereign
missions. This is the conception of the State-Gendarme. According to this conception, the
mission of the State Budget was to finance the public force, justice, diplomacy. Any other
public expenditure, especially in the economic and social sector, did not respond, according
to the Classics, to the role of the State and undermined individual freedom, private initiative
and the natural laws of the market economy.

Thus the liberal or classical current advocates economic liberalism and the abstention of the
State in the economy. We must promote laissez-faire and let the markets self-regulate
through the invisible hand dear to ADAM SMITH.

II. The Keynesian criticism

The General Theory of Employment, Interest and Money is not a theory of all economic
phenomena, it is, as its title indicates, essentially a theory of employment: it is about
highlight the processes that govern the determination of the level of this particular
macroeconomic magnitude. In this case, Keynes wants to show that the spontaneous
functioning of capitalist economies is not harmonious, that it leads to situations of massive
underemployment of factors, in particular to involuntary unemployment of the workforce.
. In classical terms, Keynes wants to demonstrate that the labor « market » can close in a
situation or remain involuntary unemployment, and this in spite of the flexibility of real
wages (which should therefore allow, according to the classical view, an adjustment
between supply. and work request). Thus the positive construction of Keynes is based on
three fundamental principles respectively: effective demand, the principle of preference to
liquidity and the legitimacy of State intervention.
1. Principle of effective demand
In the positive construction of Keynes, the volumes of production and employment are
therefore not determined as a result of the functioning of the labor market, but are
determined by the entrepreneurs according to their expectations of outlets.

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  Effective demand and Say's law
The expected demand is the demand anticipated by the entrepreneurs. The latter calculate
the production they must achieve in order to offer the optimum quantity of goods and
services demanded by economic agents. The underemployment of factors of production is,
according to Keynes, due to the fact that entrepreneurs have pessimistic expectations and
underestimate effective demand. Keynes, unlike Jean-Baptiste Say and the neo-classics,
does not reason within the framework of « perfect rationality of agents and ... perfect
information on the present and future situation »1 also effective demand depends on
forecasts of agents which may not lead to full employment.
 Effective demand and the labor market

For Keynes, salary is not only a cost, it is also an important determinant of demand.
Moreover, for Keynes, the price mechanism on the labor market does not usually lead to
full employment, hence the introduction of the concept of involuntary unemployment.

For Keynes, nominal wages w cannot fall for several reasons:

There is a viscosity of nominal wages linked to the negotiation of contracts;

A fall in nominal wages would lead to a contraction in demand which would in turn lead to
a fall in production. While for Jean-Baptiste Say supply creates its own demand, for Keynes,
insufficient effective demand will determine a supply which will not correspond to a
situation of full employment: “the mere fact that there is insufficient demand effective can
and often stops the increase in employment before it has reached its maximum ”. So, for
him, unemployment can be involuntary.

2. Principle of preference of liquidity

This principle, developed in The General Theory of Employment, Interest and Money, is
based on the notion of preference for liquidity. For Keynes, there is a demand for the
currency as such. In addition to the quantity of money necessary for current transactions,
investors also constitute precautionary savings, and another type of cash, more speculative,
corresponding to a form of investment. As the purchase of savings assets involves a risk
(of devaluation, unavailability in case of need), in an uncertain environment, agents prefer
to forgo the remuneration of their savings and opt for the most liquid investments possible,
the currency being the most liquid of all. The choice for this loss of opportunity to be

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Alan Blinder, Keynesian Economics. (wikipedia)
remunerated however adapts to the interest rates expected from the rémunérations. The
lower the rates, the more investors will tend to prefer liquidity, especially since when rates
are low, they can be expected to rise, causing bond prices to fall. Investors therefore ask
for a liquidity premium to invest for the long term.

3. Government intervation

Keynes rejected the idea that the economy would return to a natural state of equilibrium.
Instead, argued that once an economi downturn sets in, for whateve reason, the fear and
gloom that it engenders among businesses and investor will tend tobecome self-fulfilling
and can lead to a substained period of depressed economic activity and unemployment. In
reponse to this, keynes advocated a countercyclical fiscal policy in which, periods of
economy woe, the governement should undertake deficit spending to make up for thr
decline in investment and boost consumer spending in order to stabilize aggregate demand

Keynes was highlycritical o the british governement at the time. Thegovernement gretly
increased welfare spending and raised taxes to balance the national books. Keynes said
this would not encourage people to spend their money, thereby leaving the economy
unstimulated and unable to recover and return to a sucessful state. Instead, he proposed that
the governement spend more money and cut taxes to turn a budget deficit which would
increase consumer demand in the economy. This would, in turn, lead to zn increase
inoverall activity economic actiity and a reduction in unemployment.

CONCLUSION
The classical model is often termed « laissez –faire « because there is little need for the
government to intervene in managing the economy.
the keynesian model makes for greater level of government intervention, especially ina
recession when there is a need for government spending to offset the fall in private sector
investment.

Bibliography
BAILLY.J-L, CAIRE .G, (2019) Macroeconomics , chap 1et 2
Webography
http//www.wikipedia.com

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