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Lecture 2 Classical Vs Keynesian and Circular Flow of Economics
Lecture 2 Classical Vs Keynesian and Circular Flow of Economics
Lecture 2
Batch 2019-21
Classical economics and Keynesian economics
• The classical economist extended the theory of Adam Smith. Carried
by David Ricardo, Alfred Marshal, C. Pigou, J.B. Say.
• Malthus was only classical economist who emphasis demand side
and introduced a term Effective demand(ED).
• ED further modified by J.M.Keynes
Classical economics Keynesian economics
Laissez-fair approach, market is perfect Market is imperfect and not self sustaining
Government spending is not a major market force Government policy can influence demand
Both Demand and supply for labour are functions of Demand for labour depend so on real wage but
real wages supply for labour depends on money wage
The equilibrium of NI is determined at the level of Money market equilibrium and interest rate
full employment. determination by AD and AS of Money.
Government
YEAR GDP Consumption Investment Purchase Exports Imports
2004 50000 40000 80% 90000 80000 89% 140000 120000 86%
2014 100000 70000 70% 50000 45000 90% 150000 115000 77%
Where, N= 1+2+….+n
Assumptions:
1) Neither the household save from their income nor the firms save
for profits
2) Government does not play any role
3) Economy neither export nor import
Two sector model without financial market
Factor
Factorpayments
payments Expenditure
Expenditureon
on
Goods
Goods and
and
services
services
Two sector model with financial market
Expenditure
Expenditureon on
Factor
Factor Goods
Goods and
and services
services
payments
payments Or
OrConsumption
Consumptionof of
domestic
domestic
produced
produced products
products
(C
(Cdd)) Net
Net
saving
saving(S)
(S)
Cont..Two sector model with financial market
Expenditure
Expenditureon on
Factor
Factor Goods
Goods and
and services
services
payments
payments Or
OrConsumption
Consumptionof of
domestic
domestic
produced
produced products
products
(C
(Cdd)) Net
Net
saving
saving(S)
(S)
The CFI in two sector model with financial
market
The inner flow
Withdrawals
– net savings
Injections
– investment
Conclusion 1
National Expenditure (E)= C+I….(1)
Where C= consumption expenditure,
I= Private investment, and
Therefore, C+I=C+S
Or, I=S
Cont.. Three sector model
Investment
Investment(I)
(I)
Government
Government
Consumption expenditure
expenditure(G)
(G)
Consumption of of
Factor
Factor domestically
domestically
payments
payments produced
producedgoods
goods
and
andservices
services(C
(Cdd))
Net
Net
Net
Net taxes
taxes(T)
(T)
saving
saving(S)
(S)
The CFI in three sector model
The inner flow
Withdrawals
– net savings
– net taxes
Injections
– investment
– government expenditure
Conclusion 2
National Expenditure (E)= C+I+G….(1)
Where C= consumption expenditure,
I= Private investment, and
G= Government Expenditure
If G>T, government will have budget deficit. To finance the budget deficit,
government will borrow money from financial markets. Then private
investment (I) by business firm must be less than saving(S). I<S
We know that,
Y= C+I+G
or, I=Y-C-G
Therefore, Y-C-G= (Y-C-T) +(T-G)
Investment
Investment(I)
(I)
Government
Government
Consumption expenditure
expenditure(G)
(G)
Consumption of of
Factor
Factor domestically
domestically BANKS GOV. ABROAD
payments
payments produced
producedgoods
goods
and
andservices
services(C
(Cdd))
Import
Import
Net
Net expenditure
Net
Net expenditure(M)
(M)
taxes (T)
taxes (T)
saving
saving(S)
(S)
Cont…Four sector model
Export
Export
expenditure
expenditure(X)
(X)
Investment
Investment(I)
(I)
Government
Government
Consumption expenditure
expenditure(G)
(G)
Consumption of of
Factor
Factor domestically
domestically BANKS GOV. ABROAD
payments
payments produced
producedgoods
goods
and
andservices
services(C
(Cdd))
Import
Import
Net
Net expenditure
Net
Net expenditure(M)
(M)
taxes (T)
taxes (T)
saving
saving(S)
(S)
The CFI in four sector model
The inner flow
Withdrawals
– net savings
– net taxes
– import expenditure
Injections
– Investment expenditure
– government expenditure
– export expenditure
Conclusion 4
National Expenditure (E)= C+I+G +NX….(1)
Where C= consumption expenditure,
I= Private investment, and
G=Government Expenditure
NX= net export (X-M)
National Income(Y)= C+S+T…..(2)
Where C= consumption,
S= saving
T= Tax
Therefore, I+G + NX=S+T