Government contribution to the economy
Long Essay 2
John Maynard Keynes is a household name in economics. Keynes was a 20th-century British economist. He is regarded as the father of economics. Keynes developed theories of economics in which he advocated for the increased spending and lowering of taxes by the government so that economy could be stimulated in time of recession. Ideally, he suggested increased government interventions in the economy. His ideas challenged the classical framework of the economics of the day (Rotheim 45). Keynes’ economics continue to influence modern-day economics in a significant manner. Alfred Marshall, on the other hand, was a dominant economist with his Marshall’s Principle of Economics (1890) being regarded as his formidable contribution in economic literature. Marshall stressed that the output and price of goods were determined by demand and supply. Further Marshall explored marginal utility and the production costs. In this context, this paper evaluates the contributions of John Maynard Keynes and Alfred Marshal to economics.
John Maynard Keynes and his contributions to modern economics
Keynes argued that the interventionist policies by the government were fundamental in combating the excessive boom or bust cycle in the economy. This marked a shift from the long-held belief among the economists who believed that that combating excessive bust or boom cycle demanded minimal government intervention (Rotheim 45). During the Great Depression in 1929, Keynes’s ideas began to gain significance as many of his economic arguments influenced the British and American governments. The New Deal by Roosevelt was mainly influenced by Keynes’ ideologies and for many years Keynesian economics would be referenced.
General Theory of Employment, Interest, and Money was one of Keynes’ groundbreaking work in economics in which the foundation of macroeconomics lie. This seminal work challenged the consensus of the day that economy would be able to restore itself to full employment after some period of downturn. Keynes theorized that investments and savings would be determined independently of each other (Colander, 12). Savings rates would be determined by the propensity to consume while investment would be determined by the rate of return in relativity to interest rates. Further, Keynes argued that national income is the aggregate of national investment and consumption. In the time of the bust, this would likely create a spiral that never ends as businesses tend to invest less, consumption declines, unemployment rises among many other events. As such, in the unemployment period and reduced production, these problems would only be resolved by spending more on consumption and investment.
Keynes argued that the government had a role in using fiscal tools in stimulating consumption and also investments. During the economic downturn, the government should resort to deficit funding so that it could stimulate the economy (Rotheim 45). This would, therefore, lead to interest rates reduction, decreased spending on the infrastructure and public works projects, and other spending activities by the government. The argument that deficits were important to the economy became revolutionary at the time.
The multiplier effect is a major component in today’s Keynes counter cycle fiscal policy. Keynes argued that an injection of more spending by the government to the economy would lead to increased spending and more business activities. Therefore, spending tends to boost the output and this would generate more income. The magnanimity of this multiplier is related directly to the marginal propensity to consume (Rotheim 45). Ideally, individuals and households should spend more and save less which would raise the marginal propensity to consume and affect full economic growth and employment. Today many economists rely on the multiplier generated models though most argue that fiscal stimulus is not very effective. The fiscal multiplier is one of the two major multipliers in macroeconomics. The other multiplier is regarded as a monetary multiplier. This entails the process of money creation resulting from the fractional reserve banking system. This multiplier is less opposed as compared to the fiscal multiplier.
Given the fact that economies cannot stabilize themselves quickly, there is a need for quick intervention that would boost the short term demand. Employment and wages tend to be slower in responding to the economic needs and therefore government intervention is very important. Prices also do not react very quickly and change gradually only when monetary policies are used to intervene in the economy (Colander, 12). This gradual change in the prices enables usage of the money supply as an intervention tool and ensures the change in interest rates to encourage lending and borrowing. An increase in the short term demand that is initiated by cuts in the interest rates would make the economy reinvigorated and eventually restore demand and employment. Without government intervention, the cycle becomes disrupted and market growth becomes unstable and prone to fluctuations.
Alfred Marshall and his contributions to the modern economics
Alfred Marshall also made numerous contributions to economics. Concerning the study method, Marshall argued that both deduction and induction method was critical. He interpreted the partial equilibrium method (Reisman 17). The forces that influence the economic phenomena are so many that it would be very challenging in analyzing them all to arrive at an exact explanation of the phenomena. As such, the best way is to keep all other forces constant and make a study of the forces that influences the phenomena.
The other contribution by Marshall was on utility and demand. According to Marshall, the price of any commodity is determined by both the supply and demand curves and not by demand or supply as utility theorists and classical economists believed (Reisman 17). Any rational consumer aims at maximizing satisfaction from the consumption of a certain commodity. This satisfaction is very much related to the commodity quantity. Therefore demand is founded on the law of diminishing marginal utility. The satisfaction received from consuming a certain commodity can be measured in terms of utility.
Marshall also studied the concept of consumer surplus. The excess price that a consumer would be willing to pay instead of going without the commodity over what he would have paid is what Marshall regarded as the economic measure of surplus utility or satisfaction. Consumers will at times be prepared to pay a higher amount for a commodity rather than go without it. However, they pay less for it (Reisman 17). As such, the consumer enjoys surplus satisfaction. It is this argument that contributed to welfare economics. Welfare economics attracted other economists such as A.C Pigou other than Alfred Marshall.
Marshall also studies factors of production and argued that labor and land are the two major factors of production. Capital is a secondary factor in production. Man is a central figure to the production process and about consumption. More so, Marshall studied the elasticity of demand in which he argued that demand elasticity is either small or great based on whether the demanded amount is little or much for a certain fall in price (Reisman 17). He also distinguished various degrees of elasticity such as absolute elasticity, less elastic, inelastic, and highly elastic. This would lay the foundation for studying the demand for various kinds of goods such as luxuries, comforts, and necessary goods.
Ties between Keynes and Marshall Contributions to the economy
Keynes has treaded the footsteps of Marshall in analyzing the short term period and long term period separately. Keynes studies the long term period under the assumption of uncertainty while the short-term period was studied under perfect information. Concerning employment, Keynes, and Marshall differed (Colander, 12). Keynes argued that unemployment was not voluntary during the Great Depression as Marshall and other classical economists argued but were because wages were too high. Unemployment was involuntary and also caused by insufficient demand. Involuntary unemployment is when workers who are willing to work at certain wages cannot find a job since the number of job seekers is more than the available vacancies.
While Marshall believed that mass unemployment may be reduced through wage cuts, Keynes held that only government interventions could work as wages could be sticky. Marshall argued that unemployment may rise if the worker’s demand for wages exceeds the marginal product of their labor (Colander, 12). Unemployed workers according to Marshall tended to price themselves out of available jobs. From the Marshallian notion, this type of unemployment is regarded as voluntary what Keynes rejected. Despite these differences, the two economists transformed economics and the way of thinking by economists.
Short Essay 1
According to Keynes, changes in the aggregate demand whether unanticipated or anticipated have a significant short-run effect output and employments and not on prices. This idea is portrayed in the Phillips curve which shows that inflation increases slowly when the rate of unemployment has fallen (Colander, 12). More so, Keynes argued that effective demand signifies money spent on the consumption of services and goods and investment. National income is equal to total expenditure which is equivalent to the national output. The idea behind this argument is that founded in the belief that demand is a major force that drives the economy. Consequently, this theory of employment supports the expansionary fiscal policy. The main tools are government spending on unemployment benefits, infrastructure, and education among many other economic activities. However, the problem with this is that increased use of expansionary fiscal policies increases inflation
According to Alfred Marshall, unemployment is a temporary condition that will occur in an economy. More so, the unemployment condition occurs because of the interference of private organizations or government in the normal mechanism of the market forces. Over a long period, there will be full employment without inflation (Colander, 12). Given the flexibility in wage-price phenomena, the competitive market forces in the economy would maintain full employment and ensure that the economy can produce output that would level in the long run.
Keynes’ theory of employment is more profound. This is because it calls for government intervention through expansionary or contractionary fiscal policy whenever the economy is in bust of the boom cycle. More so, aggregate demand is more likely to cause short-run economic events such as recession (Colander 12). Secondly, prices and wages can be sticky, and therefore in case of an economic downturn, unemployment may result. The drawback of the Keynes theory of employment is that continuous or excessive use of fiscal policies may lead to inflation. Marshall’s Theory of economics on the other hand advocates for market forces to restore equilibrium in the long run. This may fail to work and the long-run period is uncertain.
Works cited
Colander, David. “How economists got it wrong: a nuanced account.” Critical Review 23.1-2 (2011): 1-27.
Reisman, David. The Economics of Alfred Marshall (Routledge Revivals). Routledge, 2013.
Rotheim, Roy, ed. New Keynesian Economics/Post Keynesian Alternatives. Routledge, 2013.