As part of a series where I contrast key Classical and Keynesian assumptions (read my introductory post Classical Vs. Keynesian Assumptions: An Introduction), today, I will talk about the Classical vs. Keynesian take on market structure.
The Classical model assumes that output and factor markets are perfectly competitive. What is Perfect Competition you ask? Follow this Link to Wikipedia and give it a quick read. In a nutshell, Perfect Competition refers to a market structure where there are a large number of buyers and sellers, and each participant is a price taker. No one buyer/seller has the power to impact price. The price is determined at the point where market demand is = market supply. Whenever market demand is not = market supply, the price adjusts in order to equilibrate demand and supply yet again.
As we’ve discussed before, the Classical model asserts that the economy naturally moves towards/is usually at 'Full Employment'. Full employment refers to the situation in the labour market where the demand for labour is = the supply of labour. To learn more about Full Employment, read my post What is Full Employment and Why it is Tricky to Estimate.
In order for full employment to prevail, the assumption of perfect competition is critical. Else, the economy will not move towards/remain at full employment.
The Keynesian model on the other hand, rejects the assumption of perfect competition. Keynesians believe that real-life markets are not very competitive. There are powerful monopolies (read about the characteristics of a monopoly here) and oligopolies in the real world that exert power over price in output and factor markets. The output produced in these monopoly markets lies below the full employment level of the economy. This is one reason (amongst others) why Keynesians reject the Classical assertion that markets naturally move towards full employment.
I am going to discuss and contrast Output and Price determination under Perfectly competitive and Monopoly markets in my following two posts. I’m doing this in order to explain how theoretically, perfectly competitive markets do infact tend to operate at full employment, while monopolies/monopsonies don’t.
Go ahead and read these posts (links provided below) in chronological order for this exposition:
Note: I've used a lot of microeconomics in these posts.
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