cont. ec. issues lecture 1

Contemporary Economic Issues LECTURE 1: 26 FEBRUARY 2017

Course title:

Contemporary Economic Issues

Lecture Time & Venue:

Sundays: 12:00 pm – 04:00 pm.

Lecture Theater (ب)

Lecturer:

AlMoatassem Mostafa, Ph.D.

E-mail: [email protected]

mailto:[email protected]

Course Delivery:

The course will be taught through a weekly lecture. The number of weekly hours allocated for the course is three hours. Lectures will take the form of seminar-type discussion. Specific readings for each will be specified prior to each lecture. The lecturer will be available for consultation during announced office hours or by e-mail.

Course Material:

This course is textbook-based.

Class slides will be uploaded and available for students after the class.

Essay 1: The Great Depression Reference: Rothbard, Murray Newton. America's great depression. 5th Edition. Ludwig von Mises Institute, 2000.

Contents PART I: BUSINESS CYCLE THEORY

1 THE POSITIVE THEORY OF THE CYCLE.........................3

Business cycles and business fluctuations............................................4

The problem: the cluster of error........................................................8

The explanation: boom and depression...............................................9

Secondary features of depression: deflationary credit

contraction...................................................................................14

Government depression policy: laissez-faire.....................................19

Preventing depressions......................................................................23

Problems in the Austrian theory of the

trade cycle.....................................................................................29

Contents 2 KEYNESIAN CRITICISMS OF THE THEORY..................37

The liquidity “trap”...........................................................................39

Wage rates and unemployment.........................................................42

3 SOME ALTERNATIVE EXPLANATIONS OF

DEPRESSION: A CRITIQUE....................................................55

General overproduction....................................................................56

Underconsumption............................................................................57

The acceleration principle.................................................................60

Dearth of “investment opportunities”...............................................68

Schumpeter’s business cycle theory...................................................72

Qualitative credit doctrines...............................................................75

Overoptimism and overpessimism....................................................80

Part I Business Cycle Theory1. The Positive Theory of the

Cycle A cycle takes place in the economic world, and therefore a usable cycle theory must be integrated with general economic theory.

BUSINESS CYCLES AND BUSINESS FLUCTUATIONS

It is important, first, to distinguish between business cycles and ordinary business fluctuations. People try to forecast and anticipate changes as best they can Entrepreneurs are in the business of forecasting changes on the market, both for conditions of demand and of supply. The more successful ones make profits pari passus with their accuracy of judgment, while the unsuccessful forecasters fall by the wayside.


Changes, then, take place continually in all spheres of the economy. Consumer tastes shift; time preferences and consequent proportions of investment and consumption change; the labor force changes in quantity, quality, and location; natural resources are discovered and others are used up; technological changes alter production possibilities; vagaries of climate alter crops, etc. All these changes are typical features of any economic system.


It is, therefore, absurd to expect every business activity to be “stabilized” as if these changes were not taking place. Suppose that a community is visited every seven years by the seven year locust. Every seven years, therefore, many people launch preparations to deal with the locusts: produce anti-locust equipment, hire trained locust specialists, etc. Obviously, every seven years there is a “boom” in the locust-fighting industry, which, happily, is “depressed” the other six years. Would it help or harm matters if everyone decided to “stabilize” the locust-fighting industry by insisting on producing the machinery evenly every year, only to have it rust and become obsolete? All in the name of “stabilization”?


We may, therefore, expect specific business fluctuations all the time. There is no need for any special “cycle theory” to account for them. They are simply the results of changes in economic data and are fully explained by economic theory. Many economists, however, attribute general business depression to “weaknesses” caused by a “depression in building” or a “farm depression.” But declines in specific industries can never ignite a general depression.


The problem of the business cycle is one of general boom and depression; it is not a problem of exploring specific industries and wondering what factors make each one of them relatively prosperous or depressed. In considering general movements in business, then, it is immediately evident that such movements must be transmitted through the general medium of exchange—money.


Money forges the connecting link between all economic activities. If one price goes up and another down, we may conclude that demand has shifted from one industry to another; but if all prices move up or down together, some change must have occurred in the monetary sphere. Only changes in the demand for, and/or the supply of, money will cause general price changes. An increase in the supply of money, the demand for money remaining the same, will cause a fall in the purchasing power of each dollar, i.e., a general rise in prices; conversely, a drop in the money supply will cause a general decline in prices.


On the other hand, an increase in the general demand for money, the supply remaining given, will bring about a rise in the purchasing power of the dollar (a general fall in prices); while a fall in demand will lead to a general rise in prices. Changes in prices in general, then, are determined by changes in the supply of and demand for money. The supply of money consists of the stock of money existing in the society. The demand for money is, in the final analysis, the willingness of people to hold cash balances, and this can be expressed as eagerness to acquire money in exchange, and as eagerness to retain money in cash balance.


The supply of goods in the economy is one component in the social demand for money; an increased supply of goods will, other things being equal, increase the demand for money and therefore tend to lower prices.Demand for money will tend to be lower when the purchasing power of the money-unit is higher, for then each dollar is more effective in cash balance. Conversely, a lower purchasing power (higher prices) means that each dollar is less effective, and more dollars will be needed to carry on the same work.

THE PROBLEM: THE CLUSTER OF ERROR

The main problem that a theory of depression must explain is: why is there a sudden general cluster of business errors? This is the first question for any cycle theory. Business activity moves along nicely with most business firms making handsome profits. Suddenly, without warning, conditions change and the bulk of business firms are experiencing losses; they are suddenly revealed to have made grievous errors in forecasting


Entrepreneurs are largely in the business of forecasting. They must invest and pay costs in the present, in the expectation of recouping a profit by sale either to consumers or to other entrepreneurs further down in the economy’s structure of production. The better entrepreneurs, with better judgment in forecasting consumer or other producer demands, make profits; the inefficient entrepreneurs suffer losses. The market, therefore, provides a training ground for the reward and expansion of successful, far-sighted entrepreneurs and the weeding out of inefficient businessmen


As a rule only some businessmen suffer losses at any one time; the bulk either break even or earn profits. How, then, do we explain the curious phenomenon of the crisis when almost all entrepreneurs suffer sudden losses? In short, how did all the country’s astute businessmen come to make such errors together, and why were they all suddenly revealed at this particular time? This is the great problem of cycle theory.


Another common feature of the business cycle also calls for an explanation. It is the well-known fact that capital-goods industries fluctuate more widely than do the consumer-goods industries. The capital-goods industries—especially the industries supplying raw materials, construction, and equipment to other industries—expand much further in the boom, and are hit far more severely in the depression. A third feature of every boom that needs explaining is the increase in the quantity of money in the economy. Conversely, there is generally, though not universally, a fall in the money supply during the depression.

cont. ec. issues lecture 1

Economy & Finance