Question

Keynes's criticism of the classical theory was that the Great Depression would not correct itself. The multiplier effect would restore an economy to full employment if a. government would follow a "least government is the best government" policy. b. government taxes were increased. c. government spending were increased. d. government spending were decreased.

Short answer

The correct policy to restore an economy to full employment using the multiplier effect according to Keynes's criticism of the classical theory is: c. government spending were increased.

Step-by-step solution

Understand Keynes's Criticism of the Classical Theory

According to Keynes, the classical theory failed to understand the severity of the Great Depression and believed that the economy would self-correct. However, he argued that a significant boost in economic demand was necessary to restore the economy to full employment. The multiplier effect is a concept in Keynes's theory, which states that a small increase in government spending can create a large increase in national income and employment.

Analyze the given options

We need to analyze each option and determine its impact on the economy according to Keynes's theory. a. "Least government is the best government" policy: This policy advocates for minimal government interference and would not actively address low demand. b. Increase in government taxes: Raising taxes would decrease disposable income, which could further lower demand and slow down the recovery. c. Increase in government spending: This policy aligns with the multiplier effect. By increasing government spending, demand would also increase, leading to higher national income and employment. d. Decrease in government spending: This policy would have the opposite effect of what Keynes argued. Lower government spending would reduce demand and hinder the economic recovery.

Select the correct policy

Based on our analysis of the given options and Keynes's criticism of the classical theory, we can infer that the correct policy to restore an economy to full employment using the multiplier effect is: c. government spending were increased.

Key concepts

Great Depression

The Great Depression, which began in 1929, was one of the most significant economic downturns in history. It had a profound impact on industries, banks, and millions of people worldwide. Unemployment soared, and economic activity came to a near standstill. At the time, classical economic theory suggested that markets would naturally adjust and recover on their own. However, this self-correction did not occur, leading to prolonged suffering.
John Maynard Keynes, a British economist, criticized this classical approach. He believed that active measures were needed to boost demand and reinvigorate the economy. This crisis exemplified the need for new economic theories, paving the way for Keynesian Economics. It underscored the necessity of government intervention during deep economic slumps to stabilize the economy and support recovery.

Multiplier Effect

The multiplier effect is a central idea in Keynesian Economics. It describes how an initial increase in spending can have a larger impact on the economy than the original amount spent. Imagine the government injecting money into a project, like building roads. The money paid to the workers often gets spent on goods and services, creating income for others.
The process continues with each round of spending, hence multiplying the initial effects. For example, if the government spends $1 million, and this leads to $3 million in increased economic activity, the multiplier is three. The multiplier effect highlights the powerful potential of government spending to boost national income and employment levels. It's particularly vital in times of economic distress, as it helps transform sluggish demand into robust economic growth.

Government Spending

Government spending plays a crucial role in Keynesian Economics. It acts as a catalyst for economic recovery during downturns. By injecting funds into the economy, the government can effectively stimulate demand. In periods of high unemployment and economic stagnation, like during the Great Depression, private sector activity can be insufficient to drive recovery on its own.
Increased government spending can come in various forms, like infrastructure projects, social programs, and aid to industries. These expenditures help create jobs and generate additional economic activity, which supports overall economic growth. Keynes urged governments to spend more during economic slumps, arguing that such spending could counteract low demand and lead to higher employment and production levels.

Full Employment

Full employment is a key target in Keynesian Economics, where every individual willing and able to work can find a job at prevailing wage rates. Keynes argued that without intervention, markets might not achieve full employment on their own due to insufficient aggregate demand.
During periods of economic decline, achieving full employment often requires proactive government measures. This might include increasing public spending to stimulate job creation, encouraging investment, and implementing policies that boost consumer demand. The aim is to utilize all available labor and resources effectively, ensuring a thriving economy. For Keynes, reaching full employment was essential not just for economic stability, but for societal well-being and progress.