Economics Essay Example | Topics and Well Written Essays - 3500 words

Economics - Essay Example The policies undertaken by governments in different economies are highly influenced by his theories even today. The theories introduced by Keynes mainly concentrate in the nature of total spending in the economy. The theories also analyze the influence of aggregate demand in economies inflation and output level. According to Keynes the aggregate demand created in the economy is often not equal to the productive capacity of the economy. Keynesian theories were introduced during Great Depression in the economy. Keynesian theory supports a mixed economic system, where the main sectors of the economy are headed by private business entities but are guided under the rules and regulations of the government at times of recession (Keynes, 1979). New Classical Theories of Economics New Classical theories of economics are consisted with the economic views of the modern contemporary economists. The theories mainly concentrate in the price, output and determination of income distribution in the e conomic system. The conjectures focus on the free forces of market demand and supply in the economy. These theories explain the idea of rational economic behaviour. Maximization of consumer utility subject to budget constraints or maximization of producers profit subject to cost constrains are theories of neo classical economics. It assumes that economic entities in the world undertake their economic decisions after getting equipped with the underlying relevant information. Neo Classical theories of economics dominate the Keynesian views economics (Arnold, 2008). Aggregate Supply Curve The aggregate supply curve (AS) shows the different levels of Gross Domestic Product (GDP) in real terms, generated at changed levels of prices in a particular period of time. The curve shows the relation between price and real GDP, assuming all other factors affecting real GDP constant (Ceteris Paribus assumption). The Keynesian and Neo Classical views regarding the shape of the AS curve are contrast ing. Keynesian AS curve Keynesian theory was introduced during the Great Depression when the economy was under strict recession. Due to recessionary trends in the market most of the resources were ideal and insensitive in the economy. Thus Keynesian theory firmly believed in the rigidity of price and wage rates in the economy. Keynesian theory is consistent with a horizontal AS curve where any changes in the real GDP are caused simply due to changes in the aggregate demand (AD) in the economy. It was analyzed by Keynes theory that only changes in the aggregate demand, could improve the state of a depressed economy. Figure 1 - Keynesian Horizontal AS curve CPI AD p AS q Real GDP (Source: Author’s Creation) The graph above illustrates the AD and AS curve in Keynes views. The consumer price index (CPI) is the average price level of all the goods and services produced in the economy. AD is inversely proportional to CPI as per the law of demand. The market equilibrium price (p) an d equilibrium quantity (q) of real GDP generated in the economy are determined from the point of intersection between the AD and AS curves. Rise in Government Spending Impact In order to improve the aggregate income level in the economy the government undertakes expansionary fiscal policies. These policies