The Great Depression Case of 1929

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 consumption appears to be long-term, businesses will not want to invest in increasing future production even if the interest rates are low making capital inexpensive. • During the Great Depression, the aggregate demand was very low and hence according to the Classical economists the producers should have reduced prices. They did this by reducing the wages. However instead of having the desired effect of increasing aggregate demand, it actually led to a fall in demand. As per the Keynes theory, when wages fall, it reduces the disposable income of individuals that leads to a fall in consumption expenditure and hence overall aggregate demand also falls. Thus the move of reducing wages as advocated by the classical economists worsened the situation

Agriculture based economy

Definition: Study of the allocation, distribution, and utilization of the resources used, along with the commodities produced, by farming. Any local or national economy heavily dependent on agriculture is called an agricultural based economy. Most jobs in an agricultural economy are rooted in farming.

A typical agriculture based economy involves:
Crops, greenhouse & nursery
Livestock & related products
Agriculture & forestry services
Food & beverage manufacturing
Agriculture chemicals & equipment manufacturing
Food & beverage wholesale trade
Agriculture equipment, supplies, & nursery wholesale trade
Food & beverage retail trade
Food service & drinking places
[pic]

Why can’t an agriculture based economy be an economic power?

Less employment generation: employment is defined as the annual average of monthly jobs in an industry, either full- or part-time. The land area is limited and the productivity using additional labor and capital can only be increased to a certain extent, beyond which it generates disguised unemployment. The addition to the labour force is either wasted or they are employed in a disguised manner making net zero contribution to output. ✓ Disguised unemployment: Disguised unemployment exists where part of the labor force is either left without work or is working in a redundant manner where worker productivity is essentially zero. An economy demonstrates disguised unemployment where productivity is low and where too many workers are filling too few jobs

Limited productivity: agriculture and the allied activities have many limitations making it impossible to add to the production beyond a certain limit. In such a scenario, the increase in the population is wasted and the additional output which could have been generated by using machinery, capital and additional labor force is lost. Capital and labor were perceived to be more productive in industry where economies of scale and external economies prevailed, rather than in agriculture which was subject to diminishing returns. ✓ Only a small fraction of the world’s land area—about one-tenth—may be considered arable, if arable land is defined as land planted to crops. Less than one-fourth of the world’s land area is in permanent meadows and pastures. The remainder is either in forests or is not being used for agricultural purposes.

Not much increment in the GDP: Since the employment generation is low, the production limited, the net addition to GDP is also low. To become an economic power, it’s imperative that a country is not only depended on agriculture but also has a strong industrial base.

Output affected by many factors: The output of the agriculture and related activities is affected by many uncontrolled factors like weather, rainfall, pests, warehousing etc. The countries which are food scarce are having a hard time right now due to the combination of drought and the general rise in world food prices. If commodity price instability is the way of future, we don’t want poor people to be involved in the commodity industries, in particular agriculture. Also, the resource planning is difficult and the input and output markets are inflexible.

Lower income elasticity of the demand for food: Agriculture cannot be established as an "independent" source of economic development as it has lower income elasticity of the demand for food compared with that for non-agricultural goods. Also, it is difficult for agriculture to become a foreign exchange earner. ✓ Farm output and most of the income gains are concentrated in certain regions rather than extending throughout the country. The remaining farmers are not able to produce more and actually suffer a disadvantage as farm prices decline.

Absence of positive external economies (spillover effects): Agriculture cannot enjoy the benefits associated with industrial investment; linkages between industry and other sectors and the concomitant multiplier effects industrial development could have on the overall economy.

Difficult to contain inflation: An agricultural economy without capital investment will suffer from huge inflation in case of demand supply mismatch. Also, since the agricultural produce is not under the control of the government authorities, they will not be in a position to contain it.

The CHINA success story
China has only 10% of the world’s arable land and only one quarter of the average world water resources per person. Agricultural reform has therefore been a major pillar of the fundamental economic reforms undertaken by China since 1978, resulting in a gradual transition from a centrally planned economy towards a socialist market economy. China’s agriculture is characterized by scarce land, abundant labor and small-scale production using little mechanization.

A unique element of China’s experience is that the bulk of the shift in employment has taken place within the rural economy, as agricultural workers moved to newly-developed non-agricultural industry, rather than through migration from rural to urban areas.

China economic situation and sectoral performance have improved government priorities have shifted from increasing production, especially of food grains, to rural income support and more recently to environmental concerns. China’s agriculture is characterized by scarce land, abundant labor and small-scale production using little mechanization.

To further accelerate the growth engine, China has changed its focus and now actively promotes investments in manufacturing and service industries. To become an economic power and to continue there, China gave manufacturing and production the necessary push and any country that aspires to become an economic power will have to do the same.

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

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