Problem 4 How was Keynes's position differ... [FREE SOLUTION]

Chapter 10: Problem 4

How was Keynes's position different from the classical position with respect to saving and investment?

Short Answer

Expert verified

The classical position equates saving and investment via automatic market adjustments, assuming this leads to full employment. Keynes also posits equality between saving and investment, but due to changes in income rather than interest rates, and without an assumption of automatic market stabilization at full employment.

Step by step solution

Understand the classical position on saving and investment

Classical economists believed that saving and investment are always equal. They argued that, if savings exceeded investment, interest rates would fall as a result. This decrease in interest rates would then stimulate investment until it matched savings. Equilibrium was believed to always be restored automatically.

Understand Keynes's position on saving and investment

Keynes, on the other hand, did not believe in automatic equilibrium. He proposed that saving and investment are equal at the level of income where people choose to save exactly what businesses have decided to invest. However, this point of equilibrium, according to Keynes, isn't necessarily at full employment. Thus, in contrast to classical economists, he didn't assume that markets automatically stabilize at a point of full employment.

Compare the two positions

To summarize, the classical position assumes that saving and investment are always equal due to automatic adjustments in the market, leading to full employment. Keynes also believes in equality between saving and investment, but he thinks this comes about due to changes in income rather than interest rates, and he doesn't assume that the market will automatically adjust to ensure full employment.