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Classical Economic Crises Before the Great Depression Trade-off & Conflict Analysis of growth suggests a short-term trade-off between consumption and investment The larger the surplus to be invested, the smaller the immediate consumption Consumption = mostly consumption of workers Surplus = profits of capitalists Thus conflict between workers & capitalists, labor and business Wage as Cost Business used to view wages as pure cost. the more they paid workers the less surplus available as profits Profit maximization hold wages down minimum wage laws use of force & violence, both private & public With wages at or near subsistance all wealth accumulated by capitalists Thus "class struggle" Crisis as Solution Along with laws and force,business could go on strike, i.e., refuse to invest For example in period of rapid growth, high profits and high investment, labor markets get tight, workers get higher wages, rate of profit fills and busines cuts back on investment Thus a downturn as economic activity diminishes Classical Business Cycle Output I W Q Q U W I p I time Classical Economics No "crisis" only adjustment Adjustment through markets Debate Malthus vs Ricardo Two key markets labor market financial markets Use Supply & Demand for each Labor Market wage supply of labor demand for labor quantity Says' Law Supply creates its own demand True for barter Non true for money economy money can be hoarded savings of individuals retained earnings of corporations Financial institutions channel savings/profits into investment Financial Market interest supply of loanable funds demand for loanable funds quantity Quantity Theory Quantity Theory of Money argued for stable relationship between money supply & prices Money Supply = M = piqi/V, where piqi = sum of all goods q at prices p, and V = velocity of money, where p = f(M) in short run Gold Standard International dimension of classical economics All currencies values in fixed ratio to gold, e.g. $35/ounce. All domestic money supply tied to gold, I.e, any change in amount of gold would change amount of money internally. International Acounts settled through gold transfers Adjustment Trade Deficit = more imports than exports Trade Surplus = more exports than imports Net imports gold export Net exports gold import Export of gold would reduce money supply Import of gold would increase money supply So…. A trade deficit would be cured by demand for imports caused by econ slowdown demand for imports caused by drop in relative prices exports caused by drop in relative prices Int'l Circulation of Crisis -I Acrisis in one country would circulate to others in the gold standard Contraction in economy drop in demand for imports drop in other countries exports drop in other countries levels of production Reduction in local markets increased protectionism, e.g., limits on imports to protect local industry further reductions in trade and foreign output Int'l circulation of Crisis - II Economic crises, e.g. financial collapse gold flight further deflation due to link of domestic money level to gold and further reduction in economic activity Such deflation SHOULD result in lower prices and increasingly competitive exports whose growth would spur recovery. So crisis should be corrected via shift from trade deficit to trade surplus, influx of gold, expanded money supply, reduced interest rates, etc. --End--