Download Social Studies 30 - Sundre High School

Social Studies 30
Keynesian Economics (Demand-Side interventions)
The Great Depression Changes Market Economies
The Great Depression began in 1929 and was largely the result of 2 phenomenon; a
largely unregulated banking and investment system in the United States (and other
capitalist democracies) and lack of consumer confidence in the economy once the
stock market crash began in 1929.
The period after World War One was one of rapid economic growth and prosperity.
Consumer demand for stocks over inflated the price of shares but did not represent
the true values of the companies. Eventually international protectionist policies and
European debt began to reduce international trade and American companies began
to fail. In a panic, people tried to sell their shares which drove the price of shares
far below what people had paid for them. Companies failed, creating
unemployment and further reducing consumer demand. Governments of market
economies were largely unresponsive to the crisis, believing that the downturn was
temporary and the economy would recover. As the crisis worsened and
unemployment hit close to 30%, people began to demand government intervention.
It was clear that unrestricted markets had failed.
John Maynard Keynes (1883 - 1946)

wrote The General Theory of Employment, Interest and Money, 1936

stated that government could manipulate the economy through altering the
interest rate, monetary expansion, public investment and public works,
without resorting to socialism

did not judge the success of an economy on laissez-faire principles , but
rather on
o
total output of goods produced (G.D.P.)
o
level of employment

his key point was that governments should intervene in the economy at the
right time

"New Dealers" in the United States during the Great Depression favoured
his ideas

some feel that capitalism was failing and his ideas saved the system

Keynes explained inflation and unemployment using the "Circular Flow of
Income Theory"

this consistent flow of income creates a steady level of prices and employment

however, there are two factors that affect this natural flow
o
o



consumers do not spend all they earn on purchases i.e. they
save some of their money

governments take money out of the system in the form of taxes
injections where

businesses use the money the have been saving or borrow
money to expand their business

governments spend money they have collected in taxes or
borrowed on public programs, consumers spend the money
they have saved
Keynesians believe that the ratio between leakages and injections influences
inflation and unemployment
o
when injections are greater than leakages, inflation is created
o
when leakages are greater than injections, unemployment is created
Keynesians believe they can cure the economic problems through a monetary
policy where
o
o

leakages where
if inflation is rising, they would

raise interest rates, tightening the supply of money and
discouraging consumers from borrowing and spending,
thereby forcing businesses to lower their prices to re-attract
consumer demand

this solves the short-term problem of inflation, but it creates a
long term problem of unemployment because businesses lower
their prices by cutting their costs laying people off from their
jobs
if unemployment is rising, they would

lower their interest rates, increasing the supply of money and
encouraging consumers to borrow money and spend, thereby
creating more demand from businesses, who would then hire
more workers to meet that demand

this solves the short-term problem of unemployment, but it
creates a long term problem of inflation because higher
consumer demand means businesses can charge more money
for their scarce products
Keynesians believe they can cure the economic problems through a fiscal
policy where
o
o
if inflation is rising, they would

increase government taxes to discourage consumers from
spending because they have less money in their pockets,
thereby forcing businesses to lower their prices to re-attract
consumer demand, or

reduce spending on government programs so that fewer
consumers are getting government assistance so they have less
money to spend, thereby forcing businesses to lower their
prices to re-attract consumer demand

both these actions solve the short-term problem of inflation,
but create a long term problem of unemployment because
businesses lower their prices by cutting their costs laying
people off from their jobs
if unemployment is rising, they would

lower government taxes, increasing the supply of money and
encouraging consumers to spend, thereby creating more
demand from businesses, who would then hire more workers to
meet that demand

increase spending on government programs so more people are
receiving government assistance, so they have more money to
spend, thereby creating more demand from businesses, who
would then hire more workers to meet that demand

both these actions solve the short-term problem of
unemployment, but create a long term problem of inflation
because higher consumer demand means businesses can charge
more money for their scarce products
In theory, Keynesian fiscal and monetary policies should work. However,
intervention in the economy is complex. Governments are also reluctant to curb
economic growth during times of recovery because these policies are generally not
supported by the electorate. In fact, citizens often demand more government
intervention in the form of social spending, which creates increasing debt during a
time when governments should be paying off debt incurred during the economic
downturn.