Transcript Economic Crises - University of Texas at Austin

Classical
Economic Crises
Before the Great Depression
Trade-off & Conflict
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Analysis of growth suggests a short-term trade-off
between consumption and investment
The larger the surplus to be invested, the smaller
the immediate consumption
Consumption = mostly consumption of workers
Surplus = profits of capitalists
Thus conflict between workers & capitalists, labor
and business
Wage as Cost
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Business used to view wages as pure cost.
 the
more they paid workers
 the less surplus available as profits
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Profit maximization
 hold wages down
 minimum
wage laws
 use of force & violence, both private & public
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With wages at or near subsistance all wealth
accumulated by capitalists
Thus "class struggle"
Crisis as Solution
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Along with laws and force,business could go on
strike, i.e., refuse to invest
For example in period of rapid growth, high
profits and high investment, labor markets get
tight, workers get higher wages, rate of profit fills
and busines cuts back on investment
Thus a downturn as economic activity diminishes
Classical Business Cycle
Output
 I
W
Q
Q
U
W
I
p
I
time
Classical Economics
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No "crisis" only adjustment
Adjustment through markets
Debate Malthus vs Ricardo
Two key markets
 labor
market
 financial markets
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Use Supply & Demand for each
Labor Market
wage
supply of labor
demand
for labor
quantity
Says' Law
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Supply creates its own demand
True for barter
Non true for money economy
 money
can be hoarded
 savings of individuals
 retained earnings of corporations
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Financial institutions channel savings/profits into
investment
Financial Market
interest
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supply of
loanable funds
demand
for loanable
funds
quantity
Quantity Theory
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Quantity Theory of Money argued for stable
relationship between money supply & prices
Money Supply = M =  piqi/V, where
 piqi = sum of all goods q at prices p, and
V = velocity of money, where p = f(M) in short run
Gold Standard
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International dimension of classical economics
All currencies values in fixed ratio to gold, e.g.
$35/ounce.
All domestic money supply tied to gold, I.e, any
change in amount of gold would change amount of
money internally.
International Acounts settled through gold
transfers
Adjustment
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Trade Deficit = more imports than exports
Trade Surplus = more exports than imports
Net imports  gold export
Net exports  gold import
Export of gold would reduce money supply
Import of gold would increase money supply
So…. A trade deficit would be cured by

demand for imports caused by econ slowdown
  demand for imports caused by drop in relative prices
  exports caused by drop in relative prices
Int'l Circulation of Crisis -I
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Acrisis in one country would circulate to others in
the gold standard
Contraction in economy  drop in demand for
imports  drop in other countries exports  drop
in other countries levels of production
Reduction in local markets  increased
protectionism, e.g., limits on imports to protect
local industry  further reductions in trade and
foreign output
Int'l circulation of Crisis - II
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Economic crises, e.g. financial collapse  gold
flight  further deflation due to link of domestic
money level to gold and further reduction in
economic activity
Such deflation SHOULD result in lower prices
and increasingly competitive exports whose
growth would spur recovery.
So crisis should be corrected via shift from trade
deficit to trade surplus, influx of gold, expanded
money supply, reduced interest rates, etc.
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