The Laws of Supply and Demand, Classical Economists, and the Great Depression

Classical economists believed that a free market economy would invariably self-correct in order to keep the economy in good standing. This idea did not pan out during the Great Depression although the Laws of Supply and Demand can support the reasoning behind the theory. They looked at labor as well as credit and output markets to explain the reasoning behind the theory.

In the case of labor and unemployment rates, the Law of Supply stated that the higher the wage rate for labor, the more people will be willing to work. The Law of Demand states that the higher the wage rate, the fewer employees will be hired by employers. Classical economists believed that this market would reach equilibrium, with full employment. This was not the case. If there is a surplus in labor, in order to reach equilibrium, the wage rate must shift downward. The Law of Supply shows that the lower the wage rate, the fewer available employees, thus causing voluntary unemployment. However, employers respond to the lower wage rate by increasing their staff and hiring more workers at the lower wage. Employers needed to be able to make more money in order to have more employees at this higher wage. In the case of employment, there was no way of the market leveling itself out and therefore disproving the theory held by classical economists.

Classical economists also believed that the credit market would self-correct using the Laws of Supply and Demand. The Law of Supply dictates that suppliers are willing to lend more at a higher interest rate, while the Law of Demand dictates that people and businesses are willing to borrow more at a lower interest rate. During this time period, there was an actual surplus of funds to be loaned out. People were more interested in saving as much of their money as possible and businesses were not interested in borrowing the saved income. This led to the surplus. In order to achieve equilibrium, the lenders must lower interest rates to meet demand. Unfortunately, the economy had reached such a low that people were more cautious with money and afraid of borrowing money they may not be able to pay back. This went completely against the classical economist viewpoints, proving that there was no achievable way of the credit market to self-correct.

The output market is possibly the largest area where classical economists had issues. Classical economists felt that full employment would always be utilized; therefore, a vertical supply curve where equilibrium is always met and no surpluses or shortages exist. After the stock market crash, people lost billions of dollars and demand dropped which lowered the equilibrium and caused a surplus in goods and services. A surplus in goods and services means that the prices for such goods and services would be lowered, thus increasing the real wealth of individuals and also increasing the aggregate demand. However, the surplus in goods and services caused people to become unemployed, as their services were no longer needed and making it impossible to achieve full employment. This draws back to the unemployment rate and shows that every factor included in the economy is related and affects the next factor and the next. In this case it caused an unfortunate domino effect on the economy, which spiraled even further into the Great Depression. Perhaps eventually the economy would have self-corrected and the classical economists theory could have been proven. This would have taken a very long time, if it were even possible.

Labor, credit, and output markets can all be looked at when examining the economy and theory of self-correction held by classical economists. Every market is governed by the Laws of Supply and Demand and can be illustrated in graphs to mark changes. The changes after the stock market crash in 1929 were so severe however, that the economy did not have the time or quite possibly the ability to self-correct. This showed that the classical economists were not always correct in practice, which led the country to fall into the Great Depression.

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