Question

1. Describe the economy during the Great Depression using data for the economic
   indicators that we have studied in class (e.g. GDP, unemployment rates, inflation rates, business profits and consumer confidence).
2. Before the Great Depression, classical economists such as Adam Smith, thought the economy would correct itself. It was also viewed that as long as firms produced goods, there would be people to buy those goods (This is known as “Say’s Law”). What was Keynes’ explanation of the Great Depression?
3. Explain the idea of the multiplier in words and using mathematic principles.
4. What did Keynes think should be done to correct the economy?
5. What did FDR do? Why did the economy not correct fully?
6. What impact did WWII have on the economy?

Answer 1

Keynesian economics was developed by the British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression. Keynes advocated for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression.

In economics, a multiplier broadly refers to an economic factor that, when increased or changed, causes increases or changes in many other related economic variables. In terms of gross domestic product, the multiplier effect causes gains in total output to be greater than the change in spending that caused it.The Keynesian Theory states that an increase in production leads to an increase in the level of income and therefore, an increase in spending. The value of MPC allows us to calculate the size of the multiplier using the formula:

1 / (1 – MPC) = 1 / (1 – 0.5) = 2

This means that every $1 of new income will generate $2 of extra income.

The way to break the cycle, said Keynes, is to pump government spending into the economy by building roads and bridges and other public works.Keynes overturned classical economic theory which said that free markets produce full employment. Keynes argued that aggregate demand determines the level of economic activity.

He created numerous programs to provide relief to the unemployed and farmers while seeking economic recovery with the National Recovery Administration and other programs. He also instituted major regulatory reforms related to finance, communications, and labor, and presided over the end of Prohibition.

The Hoover Administration attempted to correct the economic situation quickly, but was unsuccessful. Throughout Hoover's presidency, businesses were encouraged to keep wage rates high.The war's effects were varied and far-reaching. The war decisively ended the depression itself. The federal government emerged from the war as a potent economic actor, able to regulate economic activity and to partially control the economy through spending and consumption.