Chapter 11, Problem 1CQ

To determine

The equilibrium point and reason for the great depression lasting for a long time.

Explanation of Solution

According to Keynesian view, the equilibrium output is determined at the point where the aggregate planned expenditure is equal to the current output level. In addition, the equilibrium level of output is determined at less than full employment level of output.

During the great depression of 1930s, there was wage rigidity due to the union. Particularly, the wage rigidity was in terms of reducing wage. When the aggregate expenditure decreases, it leads to reduction in the sales and increase in the inventory. Since inventory increases, firms reduce output. The reducing output causes decrease in employment and income. When income decreases, reducing price of the good fails to increase the demand.

The decrease in aggregate expenditure reduces the aggregate demand. This in turn increases the inventory. Since actual inventory level is greater than equilibrium level, the firm reduces the output and does not increase the output even though the interest rate decreases.

Thus, the depression lasted for a long time period due to the wage rigidity and lower aggregate demand even when the rate of interest or price of the good had reduced.

Economics Concept Introduction

Aggregate expenditure: The aggregate spending or expenditure is the total spending on goods and services in an economy at a given time period. There are four components of the aggregate expenditure: consumption (C), planned investment (I), and government purchases (G), and net exports (NX).