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

Chapter Eighteen: The “macro” view of the economy 448 where there are unused idle resources that can otherwise be used by the government. As in Figure 18.1 , the logic of the model in Figure 18.2 is that increasing government comes with an opportunity cost—at the expense of the private sector. You might say, “of course.” Yet we will need to relax that assumption below in Figure 18.3 , as Keynesian macroeconomics in large part denies this opportunity cost. In the Keynesian model, full employment equilibrium is almost never achieved in the real world, such that there are always unused resources, and government expenditure can support the economy. As Keynes said, his reasoning “shows how ‘wasteful’ loan expenditure may nevertheless enrich the community on balance. Pyramid building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.” As idle workers earn income by producing government goods and services, their purchasing power from their salaries expands demand for private sector goods and services. As private sector producers receive income from sales, it is distributed to workers and shareholders, who spend it on yet other goods and services. Further, the increased demand for private output may result in increased production, which will bring yet more productive resources into the economy. In effect, spending begets further spending. This effect is called the multiplier , and is often used as justification for additional spending when economic activity is slack. We’ll pick this up again in our discussion of aggregate demand and GDP below. Yet the presence of idle resources does not necessarily mean the Keynesian theory holds. Just because resources are idle does not mean government stimulus can put the idle resources—and only idle resources—to work. In chapter 12, we identified one problem with business cycles is that capital is heterogeneous, not homogenous, in that capital is often useful in only limited applications. So, for example, a press that stamps out steel fenders for an automobile manufacturer can in no way serve as the capital necessary for a semiconductor factory. In other words, capital is often specific to its created use, and cannot be used in an Public Sector Private Sector Land, Labor, Capital, & Entrepreneurship The Macroeconomy Figure 18.2, The “Macro” Economy. We can think of the macroeconomy as using resource inputs (Land, Labor, Capital, and Entrepreneurship) to provide either public or private goods and services. To increase the public sector, the private sector must necessarily shrink. In this diagram, the dashed lines indicate a larger or smaller size of the private sector, depending on the size of the public sector, which is a collective choice outcome (politically determined). Any resources not used by the government are available for use in the private sector. Figure 18.3, The Keynesian Macroeconomy. In the Keynesian view, the private sector will only occasionally employ all available resources. Since the private sector is not able to use these resources, there is no opportunity cost for production of government goods and services. Public Sector Private Sector Land, Labor, Capital, & Entrepreneurship Idle Resource Inputs: Land, Labor, Capital The Keynesian Macroeconomy Multiplier: spending begets further spending