Answer to Question #227246 in Macroeconomics for fatima

Question

We call the model of income determination developed in this chapter a Keynesian one. What

makes it Keynesian, as opposed to classical? 

Answer 1

In economics, there are two popular school of thoughts: classical and Keynesian. The classical school believes in the role of supply in determining demand and thus, economy's income. It was highly popular before the Great Depression of 1929. While the Keynesian school considers the significance of demand in influencing overall supply and economy's output. It became popular only after the Great Depression of 1929.

The model of income determination states that the equilibrium output or income is determined when the aggregate demand for final commodities commensurates with the the aggregate supply. In this model , the equilibrium outcome is majorly determined by the aggregate demand with aggregate supply remaining stagnant due to inflexible prices.

For example, if aggregate demand for goods rises from a higher consumption , then the producers would experience a fall in their inventory of goods encouraging them to increase their production. As a result, aggregate supply would increase in response to a higher aggregate demand till the point the new equilibrium is achieved at a higher equilibrium income. Similarly, when the aggregate demand falls , then producers will face a pile up of their inventories compelling them to lower production. This reduces aggregate supply till the point it matches with the aggregate demand and thus, the new equilibrium is attained at a lower income.

Since the demand plays a significant role in determining supply , this model is called a Keynesian model of income determination not a classical one. Hence, the model of income determination is named after Keynesian because of the role of demand in deciding supply.