The Great Depression Case of 1929

Topics: Unemployment, Economics, Investment Pages: 6 (1680 words) Published: July 5, 2013
The Great Depression Case of 1929

How do you relate macro-economic during the period of Great Depression?

The macro-economy answers the questions such as
What caused the recession? Why are millions of people unemployed, even when the economy is booming? The following points answer these questions.

The fundamental cause of the Great Depression was a collapse in the aggregate demand caused by • Crash of the stock market
• Panics in the banking sector and decline in the money supply • International factors – Instability in Europe, which was still recovering from the effects of the world war • Misguided Government policies

Crash of stock market:
Average share of common stock had fallen 40% by mid-November 1929. Stocks that had been worth over $87 billion the previous summer were valued at only $18 billion. The crash wiped out many people's investments and the public was understandably shaken. When bank failures erased the savings of those who weren't even invested in the stock market, people were shattered.

Fall of the banks
A banking panic arises when many depositors simultaneously lose confidence in the solvency of banks and demand that their bank deposits be paid to them in cash. Banks, which typically hold only a fraction of deposits as cash reserves, must liquidate loans in order to raise the required cash. This process of hasty liquidation can cause even a previously solvent bank to fail. The panics took a severe toll on the American banking system. By 1933, one-fifth of the banks in existence at the start of 1930 had failed.

Decline in GNP, CPI and WPI
The industrial index fell by 37 points and the GNP declined by 25% between 1929 and 1932. The CPI fell by 25% and wholesale price index by 32%. The total farm income also slid from $12 billion to $5 billion. Capital investment almost came to a halt declining from $16.2 billion to a little more than $300 million. Unemployment also rose hitting 25% in 1933.

Industrial Decline
Construction had passed its peak and had started to decline. The inventories in 1929 were three times those of 1928. Capital investments made in this industry had created sufficient plant space and factories began to product more goods than consumers could afford to purchase.

Why market forces failed to create its equilibrium in the great depression of 1929? (Why supply failed to create its own demand in great depression).

Market equilibrium refers to a condition where a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. This perception rests upon the assumption that if a surplus of goods or services exists, they would naturally drop in price to the point where they would be consumed

• Construction and automobile industry had increased inventories (in 1929 it was three times of what was there in 1928). But the sale of automobiles was no longer increasing at a rate equal to that of their production. Also, Capital investments made in this industry had created sufficient plant space and factories began to product more goods than consumers could afford to purchase. As per the classical theory, the excess supply should have balanced the demands but it failed to do so in this case. • As per the classic theory, the unemployment was a temporary phenomenon and fall in wages will automatically bring the economy back to equilibrium. However, this theory failed as the unemployment during the Great Depression was prolonged and reached to 25% in 1933. • As per general equilibrium, if consumption fell due to savings, the savings would cause the interest rate to fall. According to classical economists, lower interest rates would lead to increase investment spending and demand would remain constant. As per Keynes, the investment does not necessarily increase in response to fall in interest rates because if a fall in...

References: http://www.imf.org/external/pubs/ft/survey/so/2011/int111111a.htm
http://www.fao.org/docrep/v4200e/V4200E0t.htm
http://www.britannica.com/EBchecked/topic/9573/agricultural-economics/68041/Peasant-agriculture
http://www.oecd.org/china/35543482.pdf
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