Great Depression

The Great Depression began in October 1929, when the stock market in the United States dropped rapidly. Thousands of investors lost great deal of money and many were wiped out, lost everything. The decline caused the Great Depression. In the period longest and worst period of high unemployment and low business activity took place. Banks, stores, and factories were closed and left millions of people jobless and homeless. Many people came to depend on the government or charity to provide them with food.

The Great Depression did not begin in 1929 with the fall of the over inflated stock market. In fact the Depression began ten years earlier in Europe. As the depression raged on in Europe American's believed they would be immune to its effects. As a result American polices never addressed the possibility of the United States entering a depression as well.

The early warning signs first came in the agricultural sector. Farmers continued to produce more and more food due to technological advances like the tractor. As production grew farm prices dropped. It was simply a matter of supply and demand. Framers reacted in the traditional manner and boosted production even further. Prices increased. Farmers began to default on their loans and the banks closed. To make matters worse the central part of the nation was hit with a terrible drought. Farmers were devastated."

Banks that had invested heavily in the stock market and real estate lost their depositors money. A panic ensued as people lined up at the banks to get their money. Unfortunately for many the money just wasn't there. As the amount of money in circulation dropped deflation hit. Money was worth more but there was little money to be had. The fed which had the power to put more money into circulation did nothing (laissez faire). Workers were fired as thousands of businesses closed down.

Unemployment rose to 25-35%. In Toledo Ohio fully 80% of the workers were unemployed. Real estate investments flopped because with deflation a building that was once worth ten million was now worth five. The mortgage and debt stayed the same but the income was gone. Banks foreclosed on loans and took possession of worthless properties that nobody could afford to buy. Between 1930 and 1932 over 9000 banks failed.

With all of this there Hoover announced to Americans that they should "stay the course" that the ship would right itself. After all, Hoover was a self made man, a rugged individualist. By the time Hoover recognized he had to do something it was too little and much too late.

The Depression affected almost all nations. It led to a sharp decrease in world trade as each country tried to protect their own industries and products by raising tariffs on imported goods. Some nations changed their leader and their type of government. In Germany, poor economic conditions led to the rise to power of Adolf Hitler. The Japanese invaded China, developing industries and mines in Manchuria. Japan claimed this economic growth would relieve the depression. This militarism of the Germans and Japanese caused the World War II.

First of all, the War made it impossible for Europe to maintain previous levels of production. For example, before the War,France, the U.K. and Germany accounted for about 60 percent1 of the world's exports of manufactured goods, a share of the market which they could not sustain during the conflict. Consequently, Europe took many of its markets to the U.S. and Japan. The growth of the European economies meant a lower demand for raw materials, which in turn lowered the demand for European exports.

In agriculture, things didn't look any better, as it was the sector which employed the most people. At the end of World War I, Europe was forced to import food from the U.S. Moreover, these transactions were conducted on a credit basis since Europe could not afford to pay for its purchase at that time.

The economics specifies the great depression in much deeper way. For example Keynes' work essentially changed the way economists view the functioning of the economy. It really is traced to Keynes' great book 'The General Theory', which in 1936 provided a new way for us to think about booms and recessions.

It's important to keep in mind when he was writing, he was writing essentially in the middle of a Great Depression, a situation where roughly a quarter of the labor force was unemployed in the United States and other developed countries.

And this was an event that economists had a lot of trouble trying to understand, trying to come up with policy recommendations to deal with.

For Mankiw the central idea in Keynes' general theory is that recessions, or depressions when they're more severe, result from inadequate demand for goods and services. Essentially people in governments and firms aren't spending enough and that's why so many people are unemployed.

According to Mankiw, it's probably most obvious in fiscal policy, because that's where Keynes argues, essentially, that the problem of the Great Depression could be solved most easily with fiscal policy. So there are a lot of examples in the US's and other countries' histories that were essentially applications of Keynes' ideas.

Similarly, when inflation was getting out of control, in the boom - it looked like it was going on too long in the late 1960s - Lyndon Johnson enacted a tax increase - a small one for largely for political reasons, but a tax increase - largely to try to slow down the economy using Keynes' arguments in reverse. So the impact on fiscal policy has been tremendous.

How About IS/LM

After great depression in 1930s, massive unemployment and greatly reduced incomes led to question the validity of classical economic theory. Many economists believed that a new model was needed to explain such a large sudden economic downturn.

Aggregate demand (AD) is important.

Ð'* Low aggregate demand is responsible for the low income and

high unemployment that characterize economic downturns.

Ð'* Criticism: aggregate supply (AS) alone determines national

income.

Different dynamics of prices in the short run and in the long run.

Ð'* In the short run: Prices are sticky, so changes in AD influence

income.