Macro

Why were Keynesian idea revolutionary?

The Classical school, they believe that market work best when they are left alone so nogovernment intervention is necessary. Any imperfections in the economy will get corrected automatically. During recession, price level will fall, purchasing power and spending of consumer rises causes increase in Aggregate Expenditure (AE). Wages will lower and reduce unemployment rate. Interest rate changes would decrease causes surplus of loan able funds and increase investment spending. These will bring the economy back to equilibrium.

Another classical school, Say’sLaw states that 'Supply creates its own demand'. It suggests that production generate income for workers and they will use their earning to purchase all the economy’s output. There should not be demand deficient unemployment. Flexibility in wages would automatically bring full employment. When consumers increase in saving, it raises the investment. Price level adjust quickly due to flexible wages and price. Hence, nogovernment intervention is necessary.

Great Depressionstruck countriesat the end of the 1920s due to collapse of stock market prices. It ruined individual investors, bank and other financial institutions. It leads to loss of confident of customer in economy and causes reduce in spending, demand as well as production. Fall in manufacture output causes unemployment rises. Many people loss their properties. Then, it came to rise of the Keynes Theory by John Maynard Keynes to solve this problem.

Keynes critiqued the assumption of classical school is wrong becausegovernment intervention is necessary to stabilize the economy. Government should implement fiscal policy to stimulatethe economy condition. During recession, expansionary fiscal policy should be used to increase government expenditure and decrease taxes. It creates budget deficit and increases the aggregate demand. During inflation, government may use the fiscal policy by decrease government expenditure...