Macro Degree Assignment - Why Were Keynesian Ideas Revolutionary?

Q1  Why were Keynesian ideas revolutionary?

In classical economics, according to well-known classical theory Say’s low, supply creates its own demand and savings is always be equal to amount of business’s investments and prices, wages and interest rates are flexible. Besides, classical economists believed that market is always clear since price would adjust by the interactions of supply and demand. Thus, the market is self-regulating and will be reaches to full employment by itself. Therefore, they believed government’s intervention is no needed.

However, in United States, the Great Depression had occurred in 1929. Industrial output was steeply decreased and nearly half of banks had failed. Besides, unemployment rates were rose as almost twenty five percentages as company’s falling. The economy was not turned back until 1939 before the World War 2.

During Great Depression, economist Keynes’s Keynesian economics were populated. By providing experiences in The Great Depression as clues, he refused to classical economics. Producers will lower the output not reduce inventories, lower production increases unemployment rate and decreases income. Thus, savings and business’s investments are not always same and wages and prices are not flexible also. He claimed that government’s intervention is needed to prevent economic depression. According to his theory, by influencing aggregate demand which is increase government expenditures and lower taxes will stimulate demand.

[pic 1]

On the other hand the classical economics said wages and prices are flexible, Keynes said actually they cannot be called flexible. When there is decline in aggregate demand lowers prices of products, money wages are moving very slowly to adjust to full employment. Therefore, this slow moving (which is not that flexible) of wages above the equilibrium makes unemployment as picture above. In right side picture, if there is reduction in investment demand, it moves AD curve to AD1. In new equilibrium K, price decreased P0 to P1 and GNP decreased Y0 o Y1.  When we assume W0 as a fixed one, real wage goes up from W0/P0 to W0/P1 and workers at R to T is being unemployed. Therefore, decrease of AD causes unemployment.

Q2  What economic problems in your news article that require government intervention?

The economic problems in the news article that require government intervention is an economic real gross domestic product (GDP) growth of Malaysia 2016. According to Centre Bank Malaysia, GDP grew at 4.5 at fourth quarter (Q4) and 4.7 per cent in the third quarter (Q3) from the corresponding period a year earlier, the worst since the second quarter of 2013. Key reason of the low GDP growth rate may because of introduction of the goods and sales tax (GST) in April 2015 and low prices of liquefied natural gas (LNG), one of Malaysia’s key exports, due to sluggish external demand were the primary reasons for slower growth, according to Deloitte University Press (Dr. Rumki Majumdar, 9 October 2015).[pic 2]