Supply vs. Demand
The dominant wisdom in macroeconomics has oscillated between the classical view that business cycles are caused by aggregate supply shocks and the Keynesian view that business cycles are caused by aggregate demand shocks. This web site develops the origins of both types of models and then traces the more modern contributions.
Clicking on the header graphic takes you directly to the table of contents.
|The Classical View
||The Keynesian View|
|Business Cycles: Supply Shocks||Business Cycles: Demand Shocks|
|Output is the product of capital and labor.
Concerns with the quantity of output overshadowed any concern over the
possibility that output would not be consumed.
|John Maynard Keynes attributed the Great Depression to demand shocks, creating a new line of thought and pushing macroeconomics to prominence.|
|Market Clearing: Yes||Market Clearing: No|
|The Classical Model is based on the simplifying abstraction that markets clear.||Keynesian models are often identified with a belief in
stickiness in wages and prices.
|Modeling Strategy: Representative Agent||Modeling Strategy: Ad Hoc|
|Given belief in market clearing, models in the classical tradition are well positioned to rely on micro foundations including sophisticated optimizing behavior. For mathematical tractability, it is common to assume that all agents in the economy are identical.||The Keynesians, on the other hand, are prone to put
forward models reasonably described as ad hoc. This tradition has grown
out of the lack (especially in the early years) of sophisticated mathematical
explanations for wage and price stickiness. The Phillips Curve is a good
example of a relationship adopted on intuitive and empirical grounds
rather than derived from optimizing behavior.