The Classical Dichotomy

The Classical Dichotomy

What is the Classical dichotomy? Under what circumstances of

disequilibrium did the Classical economist accept that the dichotomy

does not hold?

Selfishness is a reprehensible human characteristic; yet it is

precisely the necessary behavior yielding the greatest possible

economic benefit for the entire society according to Classical

economics. The dominant economic theory from the 18th to 20th century

was of a free market system of continuous competitive exchange

equilibrium in which prices and output regulate themselves perfectly

until markets achieve the market-clearing price. The Classical system

takes place in a closed economy which spontaneously moves toward

full-employment equilibrium. The principle fueling such a system is

that money wages are flexible, and the employment equilibrium is not

affected by the “nominal” amount of money in this dichotomous system.

However, there are limitations to the Classical model; mainly that it

does not work in the short-run because it fails to account for market

dynamism. The theory assumes automatic adjustment of markets from one

equilibrium to the next and ignores periods of change, or

disequilibrium. Although a static model like the Classic has its

downfalls, it is in important indicator of market forces, and is once

again gaining popularity as a “Neo-classical” model after its long

refutation by Keynesian economists.

Classical economics held that the two types of economic variables,

nominal and real, exist independently, resulting in this dichotomy of

the Classical model. Classical economist Pigou compared this

characteristic of nominal capital to...

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at the most opposing view, or Keynesian economics. While the

Classical model stresses that markets will always perfectly clear and

government should do nothing more than safeguard the functioning of

these market processes Keynes argues that markets need to helped with

a combination of monetary and fiscal policies. The question remains,

how effective is government spending in curbing periods of

disequilibrium in the economy?

References

Monetary Neutrality, “Economics A-Z.” Retrieved from The Economist

database on 13/01/2008 at

Mundell, R. “International Economics.” New York: Macmillan, 1968.

Shaw, G., McCrostie, J. & Greenway, D. “Macroeconomics: Theory and

Policy in the UK.” 3rd ed. Oxford: Blackwell, 1997.

Hillier, B. “The Macroeconomic Debate.” Oxford: Blackwell, 1991.