Overview of Classical Economics
Classical economics, developed by thinkers like Adam Smith and David Ricardo in the 18th and 19th centuries, posits that markets are self-regulating and tend toward full employment equilibrium through flexible prices and wages. It emphasizes supply-side factors, such as production and free markets, where government intervention is minimal and the economy naturally balances via the 'invisible hand'.
Core Principles of Keynesianism
Keynesian economics, introduced by John Maynard Keynes in the 1930s amid the Great Depression, argues that economies can suffer prolonged periods of underemployment due to insufficient aggregate demand. It advocates active government intervention through fiscal policy—such as increased public spending and tax cuts—to stimulate demand, boost employment, and achieve economic stability, challenging the idea of automatic market correction.
Practical Example: The Great Depression
During the Great Depression, classical theory predicted quick recovery through wage adjustments, but unemployment lingered above 20% for years. Keynesian policies, like the U.S. New Deal under FDR, involved massive government infrastructure spending, which increased demand, created jobs, and helped pull the economy out of recession—illustrating how fiscal stimulus can override market rigidities.
Key Differences and Real-World Applications
The main divide lies in their approach to recessions: classical economics favors laissez-faire policies, believing markets self-correct, while Keynesianism supports counter-cyclical interventions to mitigate downturns. In practice, Keynesian ideas influenced post-WWII welfare states and responses to the 2008 financial crisis, where stimulus packages prevented deeper slumps, though critics argue it risks inflation and debt accumulation.