Describe how expectations affects aggregate supply and demand through a classical perspective or keynesian perspective
Both classical and Keynesian perspectives acknowledge that expectations play a significant role in shaping aggregate supply and demand.
From a classical perspective, expectations primarily influence the aggregate supply side of the economy. Classical economists, such as Adam Smith and David Ricardo, believe that the economy tends to operate at its natural level of output in the long run. They argue that market forces drive the economy towards equilibrium, and any imbalances are self-correcting.
In this framework, expectations regarding future prices can impact aggregate supply. If producers anticipate higher prices in the future, they may increase production in order to take advantage of those expected price increases. This leads to an expansionary effect on aggregate supply, as firms increase their output and employment levels. Conversely, if producers foresee future lower prices, they may decrease production, leading to a contractionary effect on aggregate supply.
From a Keynesian perspective, expectations carry a stronger influence on aggregate demand. Keynesian economists, such as John Maynard Keynes, emphasize the importance of demand-side factors in determining the level of economic activity. They argue that the economy can experience prolonged periods of underemployment equilibrium, which requires active government intervention to stimulate demand and increase output.
Here, expectations predominantly affect consumer and investment spending, components of aggregate demand. If consumers and businesses hold positive expectations about the future, they are more likely to spend and invest. This leads to an increase in aggregate demand, resulting in higher output and employment. Conversely, if expectations turn negative, consumers and businesses may reduce their spending and investment, leading to a decrease in aggregate demand and a contraction in the economy.
In summary, from a classical perspective, expectations primarily influence aggregate supply through their impact on producers' decisions. From a Keynesian perspective, expectations predominantly affect aggregate demand by shaping consumer and investment spending decisions.