The Economics Book

158 DEPRESSIONS AND UNEMPLOYMENT

to suggest that Keynes originally
had some sympathy with this view.
In A Treatise on Money (1930), he
wrote that firms have three choices
when prices fall faster than costs:
to put up with the losses, close
the business, or embark on a
struggle with the employees to
reduce their earnings per unit
of output. Only the last of these,
Keynes said, was capable of
restoring real equilibrium from
the national point of view.
However, after the 1929 stock
market crash in the US and the
Great Depression that swept across
the world in its aftermath, Keynes
changed his mind. The financial
collapse of Wall Street trapped the
economies of the world in a cycle
of falling production—it fell by
40 percent in the US. By 1931,
US national income had fallen from
a pre-crash level of $87 billion to
$42 billion; by 1933, 14 million
Americans were unemployed.
Their gaunt figures haunted the
landscape, and the rapid fall in

living standards is evident in the

images of poverty and desperation

from that era. Witnessing this

devastation inspired Keynes to

write The General Theory.

The Great Depression

Keynes took the world of the Great

Depression as his starting point.

The normal workings of the market

seemed unable to create the

pressure necessary to correct the

problem of high, persistent,

involuntary unemployment in the

economy. In general, the number

of people at work is determined by

the level of real wages—the level

of wages relative to the prices of

goods and services being offered.

In times of recession prices of

goods tend to fall faster than levels

of wages because demand for

goods lowers and prices fall, while

workers resist cuts in their wage

packets. This causes the real

wage to rise. At this higher level

of real wages the number of people

willing to work will increase, and

the number of workers demanded

by firms will fall because they

are more expensive. The result

is unemployment.

Sticky wages

One way to eliminate

unemployment would be for the

excess labor (the people not

working) to create pressure on

money wages to fall by being

willing to work for less than the

The difficulty lies

not in the new ideas

but in escaping

from the old ones.

John Maynard Keynes

According to Keynes,

a depression can lead to a

vicious cycle in which

unemployment reduces

demand so much that no

new jobs can be created.

Government intervention

creates a positive circle

by stimulating demand.

Depression

The state

funds projects

that create

new jobs.

More people at

work generate

demand and

government

revenue.

Falling sales

mean that the

work force is

laid off.

Sales fall

because there

aren’t enough

people at work to

buy goods.

Recovery