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Economics U$A: 21st Century Edition

The Great Depression and the Keynsian Revolution (Macroeconomics)

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In 1932 President Herbert Hoover spoke enthusiastically about financial recovery while John Maynard Keynes expressed doubts. Keynes published The General Theory of Employment, Interest & Money in 1936, displaying ideas that later became the basis for public policy in Washington. Franklin D. Roosevelt did not generally trust economists, but his increased government spending during WWII proved Keynes’s theories correct. These stories discuss the ideas of J.M. Keynes and how the theory behind Keynsian economics explained the Great Depression.

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Unit Overview

Purpose:

To discuss how the ideas of J. M. Keynes, specifically the Keynesian multiplier, contributed to a better understanding of why the Great Depression was so severe.

Objectives:

  1. One of J. M. Keynes’s basic contributions to macroeconomics was to show how the multiplier process explains many of the swings in the economy.
  2. For example, in a single economy with no government and no trade sector, aggregate demand is equal to consumption plus investment. Income is either spent by consumers or saved. In the economy there is one leakage (saving) and one injection (investment).
  3. If investment increases, then aggregate demand increases, which in turn means that equilibrium GNP and national income increase.
    • Part of an increase of income is saved and part is spent by consumers. The new consumption spending means higher aggregate demand, more GNP, more income, and again more consumption and saving.
    • Ultimately GNP and national income will have risen by a multiple of the original rise in investment.
    • The size of this multiplier depends on how much consumers spend out of each incremental dollar of disposable income (the marginal propensity to consume). The higher the marginal propensity to consume, the higher will be the multiplier.
  4. Keynes had two main complaints about classical economics.
    • He felt that money had an impact not only on prices but also on employment and output.
    • He emphatically felt that supply did not create its own demand.

Meet the Series Experts

John Kenneth Galbraith

Economist known as the leading proponent of 20th-century political liberalism, and a prolific author who produced four dozen books and more than a thousand articles, including the popular trilogy American Capitalism, The Affluent Society, and The New Industrial State. He taught at Harvard University for many years, taking leaves to serve in the presidential administrations of Franklin D. Roosevelt, Harry S. Truman, John F. Kennedy, and Lyndon B. Johnson. He also served as United States Ambassador to India under President Kennedy. Due to his prodigious literary output, he was arguably the best-known economist in the world during his lifetime and one of a select few people to be twice awarded the Presidential Medal of Freedom. Dr. Galbraith received his B.A. from the University of Toronto and M.A. and Ph.D. in Agricultural Economics from the University of California, Berkeley.

Eric Sevareid

Prominent broadcast journalist best known for his work at CBS where he served as Chief of the Washington Bureau, 1946–1954. During World War II, he broadcast the fall of Paris to the Germans, then joined the legendary Edward R. Murrow in London, where he reported on the Battle of Britain throughout the war. He worked extensively for CBS News on television in the years following the war, and he became one of the early critics of Senator Joseph McCarthy’s anti-Communism tactics. Mr. Sevareid received his B.A. from the University of Minnesota.

Lorie Tarshis

Canadian economist credited with writing the first introductory textbook on Keynesian thinking, The Elements of Economics, in 1947. Yet, because his text was discredited by Senator Joseph McCarthy as sympathetic to communism, it was Paul Samuelson’s book that brought the Keynesian revolution to the United States. He began his academic career as an instructor at Tufts University. During World War II, he worked for the War Production Board and became a battlefield operations analyst for the Army Air Forces. After the war, he taught at Stanford, where he became Chair of the Department of Economics. Later, he taught at the University of Toronto and remained there until he retired. Dr. Tarshis received his B.A. from the University of Toronto and M.A. and Ph.D. in Economics from Trinity College, Cambridge.

Walter Salant

Economist noted for his work on John Maynard Keynes. In 1933, he attended Keynes’ lectures at Cambridge University, two years before Keynes’ publication of The General Theory of Employment, Interest and Money, the treatise that argued that industrialized economies, then mired in depression, were unlikely to recover on their own but could use government spending and tax cuts to do so. Salant later joined the fiscal policy seminar at Harvard that trained economists in the Keynesian foundation. During the Depression he served in the Treasury Department, the Securities and Exchange Commission, and the Commerce Department. During World War II, he served with the Office of Price Administration and other agencies that designed strategies for price controls. He was a senior staff member on the President’s Council of Economic Advisers, 1946–1952. Mr. Salant received his B.A. from Harvard University.

What's your Economics IQ?

Take the Economics USA: The Great Depression and the Keynsian Revolution Quiz here.

Quiz Addendum:

5. The consumption function illustrated in the diagram shows:

Answer:

that saving is done only by households with incomes over $20,000. Answer derived from diagram.

6. The average propensity to consumer of the family identified as A is:

Answer:

greater than one.

Glossary

  • aggregate demand
    The sum of expenditures on consumer goods and services, investment, and non-exports, i.e., all of demand within an economy.
  • aggregate demand curve
    A curve, sloping downward to the right, that shows the level of real national output that will be demanded at various economy-wide price levels.
  • aggregate supply curve
    A curve, sloping upward to the right, that shows the level of real national output that will be supplied at various economy-wide price levels.
  • circular flow
    Cyclical representation describing how households give money to firms, which then provide goods and services for households.
  • consumption
    The using-up of goods and services by consumer purchasing or in the production of other goods.
  • exports
    The goods and services that a country sells to other countries.
  • government purchases
    Federal, state, and local government spending on final goods and services, excluding transfer payments.
  • imports
    The goods and services that a country buys from other countries.
  • injections
    Nonconsumption expenditures on gross domestic product, including investment expenditures, government purchases, and exports.
  • Keynesians
    Economists who share many of the beliefs of John Maynard Keynes. His principal tenet was that a capitalist system does not automatically tend toward a full-employment equilibrium (due in part to the rigidity of wages). Keynesians tend to believe that a free-enterprise economy has weak self-regulating mechanisms that should be supplemented by activist fiscal (and other) policies.
  • Keynesian cross
    The standard diagram used in Keynesian economics to identify the equilibrium level of aggregate output (that is, gross domestic product), with aggregate expenditures measured on the vertical axis and aggregate output measured on the horizontal axis.
  • leakages
    Nonconsumption uses of income, including saving, taxes, and imports.
  • marginal propensity to consume
    The fraction of an extra dollar of disposable income that is spent on consumption.
  • saving
    The process by which people give up a claim on present consumption goods in order to receive consumption goods in the future.

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Economics U$A: 21st Century Edition

Credits

Produced by the Educational Film Center. 2012.
  • Closed Captioning
  • ISBN: 1-57680-895-5