20100901+notes - Lecture 2 2. Depression Economics Why We...

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Lecture 2 2. Depression Economics Why We Need a Separate Approach T HE C IRCULAR F LOW P RINCIPLE If I had had more time last time, I would have talked about the circular Fow of economic activity. I would have said that back at the start of the nineteenth century a market economy where almost everybody specialized in one particular kind of job was a new thing. ±or most of human history most people had spent most of their time working to provide for their own households: growing their own food, weaving and sewing their own clothes, building their own houses, with purchases and sales in the market restricted to a relatively small part of total economic activity. But starting in the eighteenth century economic growth brought us to a place where, in northwestern Europe at least, for the ²rst time most of what was produced was not consumed by the household that had made it, but was then sold in the marketplace and the money earned used to buy things that others had made. This market economy disturbed a great many people. “What if it all went wrong?” they asked. Consider a simple economy composed of farmers, weavers, and barbers. “Could we wind up with a situation in which the barbers were offering too many haircuts and bloodlettings that the weavers couldn’t buy, and the weavers had woven too much cloth that the farmers couldn’t buy, and that the farmers had grown too much food that the barbers could not buy—so everyone was unable to satisfy their needs because they could not sell what they had produced, and because they could not sell what they had made they could not afford to buy what others had made?” It was a worry that something like that might happen all the time. The market economy was new. Say’s Law and the Circular Flow It was ±rench economist Jean-Baptiste Say who ²rst proposed an answer back in 1803. He claimed that such a “general glut” was almost inconceivable, for every seller was also a purchaser. In a market economy, Say argued, every transaction has two sides, and nobody sells without intending to buy, and so purchasing power Fows throughout the economy in a circle. Businesses produce and sell because they then intend to spend the money they earn hiring workers and rent capital: what they pay workers and capitalists in wages, salaries, rent, income, and dividends becomes their household incomes. But workers and capitalists only sell and rent their hours and their resources to businesses because they then intend to spend the money they earn buying
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goods and services. And those goods and services that they buy—well, those are the goods and services that the businesses make. So businesses sell fnal products to households and buy Factor services From households, and households buy fnal products From and sell Factor services to businesses. The Circular Flow of Economic Activity
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20100901+notes - Lecture 2 2. Depression Economics Why We...

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