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Chapters 11

Chapter 12

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File 10 does not have questions for homework.

File 11 Questions for homework
1. What are the basic differences between classical and Keynesian economics?

A. Classical economics offered Say's Law (supply creates its own demand) 
and price-wage flexibility (resource prices adjust to ensure full employment 
of all resources) as proof that the market economy of the time was self-adjusting. 
These beliefs led to a laissez-faire (hands-off) attitude toward government 
involvement in economic activity.

B. Keynes felt the economy would not self-adjust to full employment of economic resources. 
He disagreed with Say's Law because interest rates are not the sole determinate of the 
supply and demand of loanable funds. Saving and investing are done by different people 
with many different motivations. Keynes believed government action might be necessary 
to assure full employment of economic resources.

2. Explain the 2 basic theories which gave support to classical economics. (see figure 27)

A. Say's Law 1. Supply creates enough factor income to clear the market

2. Saving is not a leakage because interest rates adjust to assure saving is borrowed and 
invested (spent)

Note: Leakage describes the loss of a variable required to maintain a process or to 
maintain a state of equilibrium (stable level of economic activity)

B. Price-wage flexibility

1. During periods of slow economic activity, wage rates would fall and everyone wanting 
to work would find work

2. During periods of slow economic activity, all factor prices, not just wages, would 
adjust downward. As a result, all factors would be fully employed.

3. Why did Keynes feel that classical economics did not adequately explain economic 
conditions of the 1930's?

A. Investment was low because profit potential was low. In addition, interest rates 
were not low enough to overcome the perception of high investment risk.

B. Wages do not decrease when economic conditions worsen because of the monopoly power
 of unions, individuals, and governments

4. Demonstrate how the classical and Keynesian models describing aggregate 
supply may be used to depict AS over the business cycle. (see figure 28 on graph page 2)

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