Understanding The Economic Crisis

Economics is really about asking questions; well actually it is concerned about asking one question in particular. How do people spend their limited resources on their needs and desires, and for what reason? For example: Pretend you are back in College (or perhaps you still are) and remember that Friday night during Finals Week. You have an exam on Monday; your friend calls up to see if you want to go see the new blockbuster Star Wars. Your choice is to spend your limited resource, time, studying for the test, or watching Star Wars. It is your decision that economists are interested in, and why you made it.

One of the questions currently dominating the national discussion is that of the role of government in fixing the current economic crisis. Should they spend? Should they cut taxes? Raise Taxes? How much? Should they leave it alone and let it self correct?

In order to do this I must first take you back to the Great Depression. Many people cite the Great Depression as an example of the failure of government spending. After all it did not work back then right? Why would it work now? During the Great Depression, demand was down, Supply was down and Real GDP fell by over 80 percent. Imagine not having the money to buy 80 percent of what you have now. Your house is 80 percent smaller, your couch is 80 percent less comfortable, and your DLP wide screen is replaced with a 21 inch CRT, complete with rabbit ears. In addition to decreased GDP, the Supply curve (what factories make) and the Demand curve (what you buy) had equilibrium (where they met) well below what would be considered full employment. In fact Employment was at 25 percent. So out of all of your friends, 1 in 4 would be sifting through the Craigslist postings today instead of heading to the driving range.

Companies will only produce what people buy. If not enough people buy a product, they will not produce it. Remember that it is companies that hire people to produce these things. If people stop buying things, then companies stop producing them and people get shown the door. This is what economists call, 'The Paradox of Thrift'; In order to increase production (and increase jobs) you need more .Modern Economists argue that the Paradox of Thrift will prevent an economy from pulling out of a recesssion onits own. One way to solve the problem is for the government to spend money on things. Another is to lower taxes (sound familiar) So if the government builds a Dam, it hires people, who make money, and who in turn spend it, increasing demand, increasing production, increasing the amount of jobs that need to be filled. You might say, well so what? It sounds good in theory, but how come it did not work back in the great depression?

I would say, yes, you are correct. We made that Dam, what was called? Hoover? Yet unemployment barely batted an eye. Remember the figures from above. Production had dropped 80 percent, unemployment had risen by 25 percent and aggregate demand fell drastically. The governments increased spending for its public works projects was only 6 percent. Not anywhere close to what would have been needed to bring demand high enough for production to increase. Not until WWII and the massive government expenditures associated with fighting a war, did the nation finally pull out of the depression. So it actually was spending that saved our economy.

Seed Newsvine

Bookmark this article in your preferred program

Comments

Add Comment

Popular Articles in this cathegory

This article is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 3.0 License.