Economic stimulus, keynesian economics

Economic stimulus 1 of 2 Keynesian economics

During the depression years, John Maynard Keynes, a British economist visited the United States to meet President Franklin D. Roosevelt. His mission was to discuss and urge the President to implement a swift solution to lift the entire world out of the depression.

His theory suggests that the reason for such a long depression is the shortage of investment spending. This dragged people’s incomes and the entire economy’s production down and stagnant. Investment spending is fueled by businesses seeking new ventures, or to develop a new product to boost revenues. However, when businesses are not fed with the necessary funds generated primarily by sales from their products or services, they would be pessimistic to spend money on new investments. These funds are coming from every single individual who buys their products or patronizes their services. Sufficient income entices people to spend more on goods and services. Thus, this picture shows us that money is flowing from the consumer to businesses and into the rest of the world who needs it. Now, let us cut back the income generated by the people. This could happen in many ways. One factor would be the rise in prices of goods and services fueled by high demand and production that couldn’t keep up. When people’s incomes are sufficient they tend to buy more goods which raise the demand for it. A sudden increase in demand can pin down producers with their current rate of production. The only way to counter this sharp rise in demand would be to increase the price to cover marginal costs.

On the consumer’s perspective they feel that they are poorer since they could buy fewer goods with their money. A common psychological response would be to trim down their spending, worried that they might not have enough to get by until the next pay comes in. With less spending by the people in effect, Businesses no longer receives enough money to generate new investments. Even simply covering their expenses is a monumental task to undertake. To compensate for this, they can either lower their prices to generate enough sales to cover expenses before due, or lay off employees to cut down costs. This is a no win situation for everyone as layoffs cuts production and lowering prices pulls profit margins to negative. This domino effect continues until enough people were laid off to seriously reduce aggregate demand. There would be so little spending by the people at this stage that some businesses can no longer breathe. Deprived from that much needed sales that could have been coming from the people. But what can we do? People don’t have enough money to keep businesses alive. If nobody spends big at this stage then this would turn into a bitter depression. Recovery would be really slow if the rate of money flowing from one hand to another is moving at snail speed.

Economic stimulus 1 of 2 Keynesian economics

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