Answer to Question #250065 in Macroeconomics for Lutendo

Question

Using diagrams and examples, compare and contrast the Classical economists’ Quantity Theory and the 

Keynesian’s Liquidity Preference Theory of money demand.

Answer 1

Solution:

The use of fiscal policy to manage aggregate demand is undervalued in classical economics. Classical theory serves as the foundation for Monetarism, which focuses solely on managing the money supply through monetary policy. According to Keynesian economics, governments must use fiscal policy, particularly during a recession to stimulate demand and jumpstart growth.

 

The long-run aggregate supply (LRAS) can be used to illustrate the difference between the Keynesian and classical views of macroeconomics.

The classical view holds that Long-Run Aggregate Supply (LRAS) is inelastic. According to the traditional view, supply-side factors such as investment, capital, and labor productivity, among others, determine real GDP. Classical economists argue that an increase in aggregate demand (faster than LRAS growth) will only cause inflation and not increase real GDP in the long run.

The Keynesian perspective on long-run aggregate supply differs. They contend that the economy may operate at less than full capacity in the long run. Keynesians argue for a greater emphasis on aggregate demand's role in causing and resolving recessions.