Answer to Question #166812 in Microeconomics for Julie

Question

Although not explicitly mentioned in Chapter 20, John Maynard Keynes is considered a foundational source in the understanding of macroeconomics. After performing research outside the textbook, please explain in three well-structured paragraphs the basic principles of the New Keynesian Economics and how it addresses perceived limitations to classic Keynesian theory.

Answer 1

New Keynesian Economics evolved from Classic Keynesian theory. New Keynesian Economics is different from Classical Keynesian theory in that it tries to show quick adjustment of wages and prices. New Keynesian economics believed that wages and prices were very slow in adjusting to short-term fluctuations. and so were regarded as sticky. This sticky wages and prices were responsible for causing involuntary unemployment and monetary policy to exert great influence on the economy. This thought was the key force in macroeconomics from 1990 to2008.

The new Keynesian theory tries to deal with the slow behaviour of prices and the reason for such slow behaviour. This theory tries to address the market failure caused due to inefficiencies and the need for government intervention. New Keynesian economics advocated expansionary monetary policy, giving the reason that deficit spending gives encouragement to saving, rather than boosting aggregate demand or lead to economic growth.

The new Keynesians believed that the market was not self-regulating while the Classical Keynesian theory believed that the market could reach equilibrium naturally. The reasons he gave were that the market may not be competitive in the true sense because monopolies may exist. Again there may be stagnation of wages because of trade unions ant the real condition of the economy may not be reflected.