No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seventeen: A Short History of Macroeconomics 425 theories. In this view, if the economy was in a period of general slackness in commerce, it was due primarily to an over-production of goods and services—or the necessary other side of the coin—the under-consumption of goods and services. The idea is basically that more goods could be produced than people had demand for, and thus the goods could not be sold at cost-covering prices. With the market price being too low to cover costs, businesses would hold out for better prices, which reduced their (and their workers’) ability to purchase other firms’ goods and services, since they would need money from sales of their own products to purchase the goods of others. This would cause a break in the circular flow from Figure 17.1 . Failure to sell at lowered market prices would lead to a vicious downward spiral—commonly called depression. While some economists supported this view, the most notable was T.R. Malthus who is nowadays more famous for his views on population control) . As Malthus said 3 , “A nation must certainly have the power of purchasing all that it produces, but I can easily conceive it not to have the will: and if we were to grow next year half as much corn again as usual, a great part of it would be wasted, and the same would be true if all commodities of all kinds were increased one half.” For Malthus, the issue is not whether production will necessarily lead to the creation of purchasing power sufficient to consume everything purchased, but whether demand would become effective demand —demand that has the capacity and the will to be exercised. If the problem was a general glut , resolution required either 1) waiting until the general overproduction was worked off, or 2) creating additional credit to provide the necessary purchasing power to buy all excess goods. Since this was a general glut, no relative price adjustments would be necessary. Indeed, as Mr. Keynes would argue subsequently, cutting prices in some areas would just exacerbate the problem. Mr. Malthus was—at a minimum—a major influence in helping Mr. Keynes clarify his own thinking on the causes of depression, ultimately leading to the publication of Keynes’ General Theory . Aahh…but we’re getting ahead of ourselves! For now, we can summarize the view of the general glut theorists: a general downturn in commerce was caused by not enough effective demand for the supply of goods produced. The second view offered a story more logically consistent with general microeconomic theory. In this view, for whatever reason (more below), there was a disproportionality between the goods and services produced. Some goods were overproduced relative to other goods and at a scale more than the normal ebb and flow of changing consumer preferences. The result was that the adjustment process resulted in not only a reduction of sales of the relatively overproduced good, but also a reduction in sales of the relatively under-produced goods, as the workers in the overproduced industries could no longer purchase the goods of the under-produced goods because their own income was reduced due to lack of sales. Note that the downward pressure includes similar rationale as with the general glut theorists: a reduction in sales in some industries could have an effect on sales to other areas. But the source of the problem was a relative oversupply of some