Question

1.) Think back to August 6, 1945. The United States has just dropped an atomic weapon on the city of Hiroshima killing tens of thousands of Japanese and devastating the infrastructure. A Keynesian at that time might conclude that there is a silver lining in the destruction, as economic prosperity will result. Evaluate this claim in a few sentences.

2.) Do people need money in order for market prices to form? Explain.

3.)  Most introductory economics textbooks have a section on “market failure.” It is here that students learn that markets may fail to achieve their potential – leaving people worse off than they theoretically could be. The existent of market failure is often taken as an excuse for government intervention to do whatever markets fail to do. In just a couple of sentences, explain why economists (and others, particularly politicians) must accept the possibility of “government failure” as well? That is, tell me why government solutions to perceived market “failures” may themselves fail to achieve their own stated goals? The U.S. Drug war is an apt example of a discrepancy between a stated political policy goal and the actual attainment of that goal.

Answer 1

1. Keynesian economists believe that government can artificially boost growth. Destruction of infrastructure can be good for growth in so far as it leads to more spending for rebuilding activities. In essence, they believe consumption is the key driver behind economic growth and the role of government is to either consume directly or to give money to people so they will spend it.

2. According to the quantity theory of money(QTM), the general price level of goods and services is directly proportional to the amount of money in circulation, or the money supply. Simply put, an increase in the quantity of money tends to increase prices.

3. Neo-classical economics states that “market failures” give ample opportunity for government intervention. However, many a times state intervention fails to correct the market failure due to a variety of reasons including political motivations, policy myopia, populist policies, conflicting objectives, bureaucracy, admin failure etc. It may be the trivial, in cases where intervention is merely ineffective, to cases where intervention produces new and more serious problems that did not exist before. Usually the Government looks for short term solutions which do not address the deep rooted cause of the problem. Also government failures distort economy and lead to inefficiencies in the economy. The cost of enforcement and monitoring is also high which also results in government failures and ineffective interventions even with well-intentioned policies/solutions.