Essay The Classical Dichotomy

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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...

... middle of paper ...

... to look
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?


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.

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