Question

In: Economics

the macro economy might have been more self-correcting in the 19th century than in the 20th century

In the notes I argue that the macro economy might have been more self-correcting in the 19th century than in the 20th century. What do I think changed by 1930 that made the Great Depression world different from the world of Adam Smith? Why was this change important?

Solutions

Expert Solution

Adam Smith believed in the principle of Laissez Faire ie the principle of free markets. According to his theory, he felt that markets have the self correcting mechanism according to which the market is capable of correcting any diversion that happen without the intervention of the government or any other such central institution.

But this changed in the 1930s when Great depression occured. During the Great depression, the unemployment rate rose upto more than 20% and even the free markets weren't able to correct this diversion. This led to failure of the laizze faire system and hence a new system was established which is the Keynesian model. It was Keynes who focused on the fact that it was the responsibility of the government or the central institution to fix the issues in the economy by providing employment, reviving the economy etc.

He also established a link between the labor market and the stock market. He believed that if the investors have less confidence in the policies or the economy, this could lead to severe consequences. The demand for goods and services reduce, unemployment increases and the economy goes into depression.

This change was important because Great depression showed that there existed an alternative theory which would have solutions for the problem of Great Depression and in order for the economy to come out of it, it was essential that the alternative policy is followed when the existing one failed.

 


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