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JOHN MAY NARD KEYNES I. The Great Depression and the fall of Classical Economics A.

focused mostly on monetary policy B. The Great Depression ( 1929 1933) started in the United States 1. the Invisible Hand of the free market slapped prosperity in the face a. Unemployment rose from 3% to 25% b. residential construction ceased c. the stock market crashed in 1929 d. average income in 1933 was lower than that in 1922 C. What caused the Great Depression? there is no simple answer because the US economy at that time has lived through dips and drops before 1. it is possible that it was due to s series of bad events: a. investments dropped after accelerating in the 1920s b. consumers decided to decrease spending and repay loans c. other nations practiced protectionism d. the Federal Reserve System opted for tighter policies D. What did Keynes advise? he believed that the British Treasury was still drunk on the old wine of classical economics and DID NOT agree with its stand of maintaining patience and promised recovery in the long run 1. The General Theory of Employment, Interest and Money (1936) rejected the classical view and presented a whole new framework for macroeconomic analysis a. attacked his predecessors directly or through caricatures **what classic models did he attack? a.1. according to the Classics, Y = C + S, If they decide to save more, demand decreases BUT this is offset because firms invest more more savings will lower the interest rate, making loans for attractive, THUS, whenever households boost their S and reduce their C, I will increase a.2. a flexible interest rate will tie I and S together therefore, this model predicts that if a recession is imminent because of lowering of C and heightened S, the interest rate will fall and boost I and this puts money in peoples pockets and sustains the flow a.3. flexible wages and prices support Says Law merchant cannot invest quickly enough to make up for decreased C and a slight recession ma result BUT wages and prices would fall in response to a fall in demand for goods and services as wages fell, unemployed workers would be hired; as prices fell, surplus would be sold and the recession would be over b. WHAT were Keynes affronts? b.1. he denied the AUTOMATIC link between S and I because households and firms save and invest for different reasons to expect interest rates to bring these together is silly if S > I, gluts would happened, leading to surplus, unemployment and even less C

b.2. rejected fluid, flexible wages and prices workers will refuse to lower nominal wages b.3. in a recession, firms lower I S = I not because I rises but because of lowered S ( as laid-off workers cannot afford to save) also, because wages and prices take a long time to adjust, prolonged recessions or depression are possible. II. The Keynesian Solution: Depression occur when total demand for goods and services is less than total income. A. What is a depression? a result of inadequate demand for goods and services by household and firms. If purchases are not enough, firm will law off workers and this decreases output B. The Keynesian Model 1. households purchases and C are done by this unit households are the most important component of overall demand income is the chief determinant of C 2. firms also buy good and services and do not change their investment plans in response to mere short-run changes in incomes 3. To achieve full employment, households must consume enough and firms must invest enough that sales of goods equal the amount produced a. if Y = C, then Says Law would produce full employment BUT since Y = C + S, I should make up for the savings if S is not made into I, inventories would rise and laying off would happen the problem is deficient demand for goods and services 4. Keynes urged citizens to spend more a. claims that well-intentioned savers inflict more harm to an economy than any wicked capitalist b. believes that the harm done compounds itself through the Keynesian multiplier any change in spending by one person starts a snowball effect and the ultimate change in national spending surpasses the initial change C. Lets start the ball rolling. if deficient demand incites recession, then the solution must be to boost spending spending can be injected into the economy, which will multiply throughout and cure the recession by filling the original gap between output and sales 1. Who should start spending? GOVERNMENT!! a. the government can either cut taxes or spend money directly to regulate the economy a.1. when the economy slowed, government can boost federal spending or cut taxes, leading to temporary deficits until the economy rebounded a.2. if demand rose too quickly, gradually resulting in shortage and pressuring prices upward, a thrifty G and raised taxes can rein in demands III. The State of Long Term Expectation - from the twelfth chapter of the General Theory contains his take on the stock market A. explains why the hope of mathematical precision in economics is folly because of the element of human behavior

B. sought to describe the innate volatility of investment 1. I is incited by animal spirits irrational forces impelling businessmen and speculators forward and these forces are not consistent.