Prepared by:Nitin Narang

Economists Marshall, Smith, Pigou believed in the

existence of full employment in the Laissez faire economy.

They believed that there was a self adjustment system in the

economy. But this theory didn’t showed at the time of

Great Depression. This theory was criticized by Keynes.

Keynes then said that role of government is important in the

recovery from depression.

• Given by Adam Smith, Marshall and Pigou.

• Believed in existence of full employment in the economy and

considered it as a normal situation.

• Existence of automatic adjustment mechanism in the economy.

• Wages, prices and ROI were assumed as flexible

Cut Wage Rate

Reduction in Cost

Prices will fall

Increased Demand

More Employment

Full Employment Equilibrium

• Higher wages will lead to more supply

of labour but less demand of it, so wage

prices will fall to establish equilibrium.

• Lower wages will lead to less supply

of labour but more demand of it, so

wage price will rise to establish

equilibrium.

S= f(r)

I= f(1/r)

S=I

Equilibrium occurs when,

Savings = Investment

• Based on quantity theory

of money.

• Higher price level in the

market indicates higher

money supply.

• P = f(M)

• Failed during the Great Depression of 1930’s.

• Self Adjustment was not possible

• State intervention was necessary.

• Underemployment equilibrium was possible.

• Great Depression caused lack of consumption and

AD decreased.

• Investment also didn’t increased due fear of losses.

• Self adjusting mechanism failed .

• Keynes said that government intervention is

necessary.

• He also stated that underemployment equilibrium

also occurs.

• In short period, level of national income is determined

by aggregate demand and aggregate supply.

• Equilibrium is established when,

AD = AS

According to Keynes, equilibrium

could be established at

underemployment as well when,

AD = AS.

Equilibrium could be established

when the demand is not at its peak

and still more employment could be

generated.

• Ignorance of long run equilibrium.

• Perfect competition unrealistic.

• Role of government as an investor is considered. But

as a spender and taxer it is ignored.

• It is economics of depression only.

• There is time lag.

CLASSICAL KEYNES

Full employment is a normal

situation

Full employment unrealistic

Laissez-faire economy. Government intervention is

required.

Automatic self adjusting system. Denied self adjusting system.

Full employment equilibrium. Under-employment equilibrium

Money is only medium of

exchange.

Money is a medium of exchange

and acts as a store of value as well.