Chapter 25: Problem 16

How did the Keynesian perspective address the economic market failure of the Great Depression?

Short Answer

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The Keynesian perspective addressed the economic market failure of the Great Depression by advocating for government intervention to boost aggregate demand and stimulate economic activity. It highlighted the importance of aggregate demand in determining an economy's output and emphasized the need for increased government spending and reduced taxes to encourage business growth and reduce unemployment. The implementation of Keynesian policies, such as President Franklin D. Roosevelt's New Deal programs, played a crucial role in alleviating the economic hardships experienced during the Great Depression.

Step by step solution

1. Understanding the Keynesian perspective

The Keynesian perspective, named after the British economist John Maynard Keynes, argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes. According to Keynes, the government should, therefore, intervene in the economy to alleviate economic fluctuations and improve overall economic stability.

2. Causes of the Great Depression

The Great Depression, which occurred in the 1930s, was the deepest and longest-lasting economic downturn in the industrialized Western world. Several factors contributed to the Great Depression, including a stock market crash, bank failures, a decrease in consumer spending, and an overall lack of confidence in the economy.

3. Role of aggregate demand in Keynesian theory

According to Keynes, an economy's output is determined by the level of aggregate demand, which is the total spending on goods and services in an economy. When aggregate demand is low, businesses will produce less, leading to unemployment and lower economic growth.

4. Government intervention in the economy

Keynes argued that the government should actively intervene in the economy to avoid or shorten economic downturns. By increasing government spending, lowering taxes, or both, the government can boost aggregate demand, stimulate economic activity, and encourage businesses to hire more workers.

5. Application of Keynesian economics in the Great Depression

During the Great Depression, the U.S. government implemented several Keynesian policies in an attempt to revive the economy. President Franklin D. Roosevelt's New Deal programs, for example, increased government spending on infrastructure, public works, and social programs, which in turn boosted aggregate demand and helped to reduce unemployment.

6. The legacy of the Keynesian perspective

The Keynesian perspective has had a significant impact on economic policy since the Great Depression. It has influenced government actions during several other economic downturns, including the recession of the 1970s and the more recent 2008 financial crisis. While some critics argue against government intervention in the economy, it is widely accepted that Keynesian policies played a crucial role in alleviating the economic hardships during the Great Depression.

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