Question

Until the Great Depression, the dominant schoo economic thought was \((\mathrm{LO} 4,5)\) a) classical economics b) Keynesian economics c) supply-side economics d) monetarism

Short answer

The dominant school of economic thought before the Great Depression was a) Classical Economics.

Step-by-step solution

Introduce the economic theories

To solve this exercise, let's start by introducing the four economic theories presented in the options: a) Classical Economics b) Keynesian Economics c) Supply-side Economics d) Monetarism

Explain Classical Economics

Classical Economics includes the ideas of Adam Smith, David Ricardo, and other economists who believed in the self-regulating nature of the market. They argued that markets are efficient and government intervention should be limited. The ideas of classical economists were dominant during the late 18th and early 19th centuries.

Explain Keynesian Economics

Keynesian Economics is based on the ideas of John Maynard Keynes, which gained popularity mostly during and after the Great Depression. Keynes argued that the government should play a significant role in the economy to counteract market failures such as underemployment and insufficient demand. This school of thought was dominant from the 1930s to the 1970s.

Explain Supply-side Economics

Supply-side Economics focuses on the policies that increase the production of goods and services in the economy, such as tax cuts and deregulation. This school of thought gained popularity during the 1980s, with Ronald Reagan's economic policies in the United States.

Explain Monetarism

Monetarism is an economic theory that emphasizes the role of monetary policy (i.e., controlling the money supply) in stabilizing the economy. This school of thought, developed by economists such as Milton Friedman, became prominent in the late 20th century.

Identify the dominant theory before the Great Depression

To answer the question, we need to determine which economic theory was dominant before the Great Depression that started in 1929. Based on the information provided, Classical Economics was the dominant school of thought before the Great Depression. So, the correct answer is: a) Classical Economics

Key concepts

Keynesian Economics

Imagine a world where the government steps in to help when the economy is struggling. This is the essence of Keynesian Economics. John Maynard Keynes proposed this theory during the Great Depression, a time when economies around the world were battling high unemployment and low demand.
Keynes believed that, in times of economic downturn, the market doesn't always correct itself quickly. Instead, he suggested that the government should play an active role.

• Increase government spending to boost demand.
• Reduce taxes to leave more money in the hands of consumers.
• Implement public works and infrastructure projects to create jobs.

These actions aim to kick-start economic activity by increasing consumer spending. When consumers have more money to spend, businesses see more demand for goods and services.
This demand encourages businesses to produce more, hire more workers, and eventually leads to economic recovery. The ideas of Keynesian Economics were the guiding star for many governments from the 1930s to the post-war era.

Supply-side Economics

Supply-side Economics pivots from focusing on demand to emphasizing supply. The central idea is that economic growth is best stimulated by boosting the supply of goods and services.
During the 1980s, this approach gained fame, particularly through the policies of Ronald Reagan, often referred to as "Reaganomics." Here’s how it works:

• Reduce taxes, especially on businesses and high earners, to incentivize investment.
• Deregulate industries to allow for more business innovation and efficiency.
• Encourage production by creating an environment where businesses can thrive with fewer barriers.

The philosophy rests on the belief that when producers (businesses) keep more of their profits, they will invest in new products and technologies. This investment leads to economic expansion, which then trickles down and benefits all social classes.
Critics, however, argue that the trickle-down effect often fails to materialize effectively and can lead to increased inequality.

Monetarism

Monetarism centers around the management of the money supply within an economy. At the heart of this economic theory is the concept that controlling money can influence economic health.
A key figure in Monetarism is Milton Friedman, who argued that inflation is always a monetary phenomenon. Let's break down some core ideas:

• Regulate money supply to maintain economic stability.
• Avoid excessive money printing to prevent high inflation.
• Reduce government intervention and allow market forces to operate freely.

Monetarists believe that when the money supply grows too quickly, inflation spikes, eroding the real value of money. Conversely, when it's too tight, it can lead to economic stagnation.
This school of thought gained traction in the late 20th century and influenced policies where central banks, like the Federal Reserve, became more pivotal players in steering the economy. Like all schools of thought, Monetarism isn't without critique; some argue it oversimplifies complex economic dynamics.