demand-side-economics

Demand-side Economics

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Demand side economics refers to a belief that economic growth and full employment are driven by the demand for products and services.

AspectExplanation
DefinitionDemand-side Economics, often referred to as Keynesian Economics, is an economic theory and policy approach that emphasizes the role of aggregate demand in driving economic activity. It is based on the ideas of British economist John Maynard Keynes and gained prominence during the Great Depression. The theory posits that during economic downturns, government intervention and policies, such as increased public spending and monetary stimulus, can stimulate consumer and business spending, thereby boosting demand, production, and employment. Demand-side economics contends that managing demand, particularly during recessions, is crucial for stabilizing economies and achieving full employment. It stands in contrast to supply-side economics, which focuses on stimulating production and reducing regulations to promote economic growth.
Key Concepts– Aggregate Demand: The total demand for goods and services in an economy, consisting of consumption, investment, government spending, and net exports. – Multiplier Effect: An initial increase in spending can lead to a larger overall increase in economic activity. – Fiscal Policy: The use of government spending and taxation to influence economic conditions. – Monetary Policy: The use of central bank tools, such as interest rates, to influence the money supply and borrowing costs. – Counter-Cyclical Policies: Government actions designed to offset economic fluctuations and stabilize the economy.
Characteristics– Government Intervention: Demand-side economics advocates for government intervention to manage economic cycles. – Counter-Cyclical Measures: Policies are designed to counteract economic downturns by boosting demand. – Consumer Confidence: Increasing consumer and business confidence is a key goal to stimulate spending. – Full Employment: The theory aims to achieve full employment by managing demand fluctuations. – Public Investment: Support for public infrastructure projects is often a component of demand-side policies.
Implications– Stimulating Growth: Demand-side policies can help stimulate economic growth during periods of recession or stagnation. – Employment: Focusing on demand can lead to increased employment opportunities. – Inflation Control: Policymakers must carefully manage demand to avoid excessive inflation. – Government Spending: Increased government spending is a common tool to boost demand. – Consumer Confidence: Measures that increase consumer and business confidence can have positive effects on the economy.
Advantages– Economic Stabilization: Demand-side policies can help stabilize economies during recessions and prevent prolonged downturns. – Employment: The approach aims to maximize employment levels, reducing unemployment rates. – Consumer and Business Confidence: Effective demand management can boost confidence in the economy. – Social Welfare: Policies can help reduce poverty and social inequality by providing job opportunities. – Crisis Response: Demand-side economics offers a framework for responding to economic crises.
Drawbacks– Inflation Risks: Overly aggressive demand-side policies can lead to inflationary pressures. – Budget Deficits: Increased government spending may result in budget deficits. – Debt Accumulation: The accumulation of government debt can be a concern with persistent deficit spending. – Effectiveness: The effectiveness of demand-side policies may vary depending on the economic context and implementation. – Crowding Out: High government borrowing can crowd out private investment.
Applications– Financial Crisis Response: During financial crises like the 2008 global financial crisis, governments implemented demand-side policies to stabilize the financial system and stimulate economic activity. – COVID-19 Pandemic: In response to the economic impact of the COVID-19 pandemic, many countries employed demand-side measures, such as direct stimulus payments and expanded unemployment benefits. – Infrastructure Investment: Governments often invest in infrastructure projects as a way to boost demand and create jobs. – Unemployment Reduction: Demand-side policies are used to reduce unemployment rates during economic downturns. – Consumer Confidence Building: Efforts to boost consumer and business confidence are part of demand-side strategies.
Use Cases– Great Depression: The New Deal in the United States, led by President Franklin D. Roosevelt, was a historic example of demand-side policies aimed at countering the economic devastation of the Great Depression. – Recovery from Recessions: Governments around the world have used demand-side policies to facilitate recovery from recessions and financial crises. – Global Economic Downturns: Demand-side strategies have been applied in response to global economic downturns, including the 2008 financial crisis and the COVID-19 pandemic. – Public Infrastructure: Investments in public infrastructure, such as roads, bridges, and airports, are common demand-side measures to create jobs and stimulate economic activity. – Consumer and Business Confidence: Measures aimed at boosting consumer and business confidence are essential components of demand-side strategies.

Understanding demand side economics

Demand side economics was developed by British economist John Maynard Keynes who described the theory in his 1936 book The General Theory of Employment, Interest and Money. For this reason, the theory is also known as Keynesian economics.

Keynes posited that economic growth was driven by effective demand, or the demand for products and services.

He also believed that consumer spending led to business expansion and in turn, to more employment opportunities.

More employment then creates a multiplier effect that further increases demand and thus economic growth. 

This idea contradicts those espoused by classic and supply-side economists who argue that demand is driven by the production and supply of goods and services.

Demand side economics and the Great Depression

Keynes refined his theory in response to the Great Depression in the 1930s. Classical economists of the time believed that economic balance would ultimately be restored via market supply and demand forces.

However, this did not prove to be the case.

In the aftermath of the stock market crash, the market failed to return to equilibrium and many remained unemployed.

Classical economic theory could not explain this outcome, but Keynes was quick to point out that demand – not supply – was the driver of economic growth. Workers were unemployed and factories sat idle because there was no demand for products.

Keynes then noted that government intervention was necessary to promote growth and restore market equilibrium.

In the process, he established a new school of thought in economics that focused on demand and lives on in various forms today.

Government intervention using demand side economics

Governments can intervene by:

  • Lowering interest rates – this makes it easier for consumers to pay off debt and increases discretionary income/spending.
  • Public works and infrastructure projects – these are popular options because they tend to deliver superior ROI over time. 
  • Tax cuts – where lower to middle-class individuals receive tax cuts in preference to wealthier taxpayers. For example, the Earned Income Tax Credit (EITC) was a critical part of the Obama administration’s response to the 2008 GFC.

These measures push more money into the market and increase the buying capacity of consumers.

In response, factories and other producers are encouraged to create more goods which increases employment.

Lowering interest rates is particularly effective because it determines liquidity preference, or the desire for consumers to spend or save money.

Demand-side economics favors monetary expansion which causes interest rates to decrease, which makes it more attractive for individuals and businesses to borrow money and stimulate the economy further.

Case Studies

  • Response to the 2008 Financial Crisis (United States):
    • Description: After the 2008 financial crisis, the United States government implemented demand-side policies to stimulate economic recovery. These policies aimed to boost aggregate demand, restore confidence in financial markets, and create jobs.
    • Fiscal Stimulus (American Recovery and Reinvestment Act – ARRA): The government allocated funds for infrastructure projects, tax cuts, unemployment benefits, and social welfare programs. By injecting money into the economy, the government stimulated consumer spending and business investment.
    • Monetary Policy (Federal Reserve): The Federal Reserve pursued expansionary monetary policies, such as lowering interest rates and implementing quantitative easing. These measures aimed to reduce borrowing costs, encourage investment, and increase access to credit for businesses and consumers.
    • Impact: The combination of fiscal stimulus and monetary easing stabilized financial markets, boosted consumer and business confidence, and supported economic recovery. Job creation increased as businesses expanded operations and invested in new projects, contributing to overall growth.
  • COVID-19 Pandemic Response (Various Countries):
    • Description: During the COVID-19 pandemic, governments worldwide employed demand-side measures to mitigate the economic impact of lockdowns and disruptions. These measures aimed to support households, businesses, and financial markets while maintaining aggregate demand.
    • Fiscal Stimulus Packages: Governments provided direct cash payments to individuals, enhanced unemployment benefits, and grants for small businesses. These measures aimed to sustain consumer spending and prevent a sharp decline in demand.
    • Monetary Policy Response: Central banks lowered interest rates and provided liquidity support to financial markets. By reducing borrowing costs and ensuring financial stability, monetary authorities supported economic activity and investment.
    • Impact: Demand-side interventions helped prevent a deeper economic downturn by supporting household incomes, maintaining consumer spending, and preserving business confidence. Government support measures cushioned the impact of the crisis on vulnerable populations and businesses, contributing to economic resilience.
  • Public Infrastructure Investment (Various Countries):
    • Description: Governments invest in public infrastructure projects to stimulate economic growth and create jobs. These investments generate demand for goods and services, support economic activity, and enhance long-term productivity and competitiveness.
    • Infrastructure Projects: Countries invest in transportation (roads, bridges, public transit), energy (renewable energy projects, transmission networks), and other sectors. These projects create employment opportunities and stimulate demand for construction materials and equipment.
    • Multiplier Effect: Infrastructure spending generates a multiplier effect, where each dollar invested generates additional economic activity through downstream spending and job creation. This multiplier effect amplifies the impact of government investment on aggregate demand.
    • Impact: Public infrastructure investment stimulates economic growth, improves infrastructure quality, and enhances the overall competitiveness of the economy. By creating jobs and supporting industries, infrastructure projects contribute to sustained economic expansion and development.
  • Unemployment Reduction Programs (Various Countries):
    • Description: Governments implement programs to reduce unemployment and support labor market participation during economic downturns or structural transitions. These programs aim to stimulate demand for labor, facilitate job creation, and address unemployment challenges.
    • Job Creation Schemes: Governments may initiate public works programs, community service projects, or subsidized employment programs to create jobs for unemployed individuals. These programs provide income support and work experience while boosting aggregate demand.
    • Workforce Training Initiatives: Training programs and vocational education help unemployed individuals acquire new skills and transition to sectors with high-demand occupations. By investing in human capital, governments enhance employability and promote labor market mobility.
    • Wage Subsidies: Governments offer wage subsidies to employers who hire and retain workers, particularly during economic downturns. These subsidies reduce labor costs for businesses and encourage hiring, thereby supporting job creation and reducing unemployment rates.
    • Impact: Unemployment reduction programs stimulate labor demand, facilitate workforce reintegration, and alleviate the socio-economic impacts of unemployment. By supporting job creation and skills development, these initiatives contribute to economic recovery, social stability, and inclusive growth.

Key takeaways:

  • Demand side economics refers to a belief that economic growth and full employment are driven by the demand for products and services. The theory was developed by British economist John Maynard Keynes in the 1930s.
  • Keynes refined his theory in response to the Great Depression in the 1930s as classical economists failed to explain why the market and employment levels did not rebound after the 1929 crash.
  • Governments can intervene using demand side economics by funding infrastructure projects, implementing low and middle-class tax cuts, and lowering interest rates.

Key Highlights

  • Demand Side Economics Definition: Demand side economics, also known as Keynesian economics, asserts that economic growth and full employment are primarily driven by the demand for products and services.
  • Developed by John Maynard Keynes: British economist John Maynard Keynes introduced this theory in his 1936 book “The General Theory of Employment, Interest and Money.”
  • Role of Effective Demand: Keynes believed that economic growth stems from effective demand, which represents the consumer demand for goods and services. Consumer spending leads to business expansion, increased employment, and a multiplier effect that further boosts demand and economic growth.
  • Contrasting with Classical Economics: Demand side economics contradicts classical and supply-side economic theories that emphasize supply and production as the main drivers of the economy.
  • Response to the Great Depression: Keynes developed his theory in response to the Great Depression of the 1930s. He argued that demand, not supply, was the key factor in economic growth. Unemployment and idle factories were a result of insufficient demand.
  • Government Intervention and Measures:
    • Lowering Interest Rates: By reducing interest rates, governments can make it easier for consumers to pay off debt and increase discretionary spending.
    • Public Works and Infrastructure: Governments can invest in public projects and infrastructure, yielding long-term returns.
    • Tax Cuts: Tax cuts targeted at lower and middle-class individuals, such as the Earned Income Tax Credit (EITC), can boost consumer buying capacity.
  • Effect of Government Intervention: These measures inject more money into the market, leading to increased consumer spending and incentivizing producers to create more goods and generate more employment.
  • Monetary Expansion and Interest Rates: Demand side economics favors monetary expansion, which lowers interest rates. This encourages borrowing by individuals and businesses, stimulating the economy further.

Connected Economic Concepts

Market Economy

market-economy
The idea of a market economy first came from classical economists, including David Ricardo, Jean-Baptiste Say, and Adam Smith. All three of these economists were advocates for a free market. They argued that the “invisible hand” of market incentives and profit motives were more efficient in guiding economic decisions to prosperity than strict government planning.

Positive and Normative Economics

positive-and-normative-economics
Positive economics is concerned with describing and explaining economic phenomena; it is based on facts and empirical evidence. Normative economics, on the other hand, is concerned with making judgments about what “should be” done. It contains value judgments and recommendations about how the economy should be.

Inflation

how-does-inflation-affect-the-economy
When there is an increased price of goods and services over a long period, it is called inflation. In these times, currency shows less potential to buy products and services. Thus, general prices of goods and services increase. Consequently, decreases in the purchasing power of currency is called inflation. 

Asymmetric Information

asymmetric-information
Asymmetric information as a concept has probably existed for thousands of years, but it became mainstream in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.

Autarky

autarky
Autarky comes from the Greek words autos (self)and arkein (to suffice) and in essence, describes a general state of self-sufficiency. However, the term is most commonly used to describe the economic system of a nation that can operate without support from the economic systems of other nations. Autarky, therefore, is an economic system characterized by self-sufficiency and limited trade with international partners.

Demand-Side Economics

demand-side-economics
Demand side economics refers to a belief that economic growth and full employment are driven by the demand for products and services.

Supply-Side Economics

supply-side-economics
Supply side economics is a macroeconomic theory that posits that production or supply is the main driver of economic growth.

Creative Destruction

creative-destruction
Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.

Happiness Economics

happiness-economics
Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.

Oligopsony

oligopsony
An oligopsony is a market form characterized by the presence of only a small number of buyers. These buyers have market power and can lower the price of a good or service because of a lack of competition. In other words, the seller loses its bargaining power because it is unable to find a buyer outside of the oligopsony that is willing to pay a better price.

Animal Spirits

animal-spirits
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage.  Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.

State Capitalism

state-capitalism
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.

Boom And Bust Cycle

boom-and-bust-cycle
The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.

Paradox of Thrift

paradox-of-thrift
The paradox of thrift was popularised by British economist John Maynard Keynes and is a central component of Keynesian economics. Proponents of Keynesian economics believe the proper response to a recession is more spending, more risk-taking, and less saving. They also believe that spending, otherwise known as consumption, drives economic growth. The paradox of thrift, therefore, is an economic theory arguing that personal savings are a net drag on the economy during a recession.

Circular Flow Model

circular-flow-model
In simplistic terms, the circular flow model describes the mutually beneficial exchange of money between the two most vital parts of an economy: households, firms and how money moves between them. The circular flow model describes money as it moves through various aspects of society in a cyclical process.

Trade Deficit

trade-deficit
Trade deficits occur when a country’s imports outweigh its exports over a specific period. Experts also refer to this as a negative balance of trade. Most of the time, trade balances are calculated based on a variety of different categories.

Market Types

market-types
A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.

Rational Choice Theory

rational-choice-theory
Rational choice theory states that an individual uses rational calculations to make rational choices that are most in line with their personal preferences. Rational choice theory refers to a set of guidelines that explain economic and social behavior. The theory has two underlying assumptions, which are completeness (individuals have access to a set of alternatives among they can equally choose) and transitivity.

Conflict Theory

conflict-theory
Conflict theory argues that due to competition for limited resources, society is in a perpetual state of conflict.

Peer-to-Peer Economy

peer-to-peer-economy
The peer-to-peer (P2P) economy is one where buyers and sellers interact directly without the need for an intermediary third party or other business. The peer-to-peer economy is a business model where two individuals buy and sell products and services directly. In a peer-to-peer company, the seller has the ability to create the product or offer the service themselves.

Knowledge-Economy

knowledge-economy
The term “knowledge economy” was first coined in the 1960s by Peter Drucker. The management consultant used the term to describe a shift from traditional economies, where there was a reliance on unskilled labor and primary production, to economies reliant on service industries and jobs requiring more thinking and data analysis. The knowledge economy is a system of consumption and production based on knowledge-intensive activities that contribute to scientific and technical innovation.

Command Economy

command-economy
In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.

Labor Unions

labor-unions
How do you protect your rights as a worker? Who is there to help defend you against unfair and unjust work conditions? Both of these questions have an answer, and it’s a solution that many are familiar with. The answer is a labor union. From construction to teaching, there are labor unions out there for just about any field of work.

Bottom of The Pyramid

bottom-of-the-pyramid
The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”

Glocalization

glocalization
Glocalization is a portmanteau of the words “globalization” and “localization.” It is a concept that describes a globally developed and distributed product or service that is also adjusted to be suitable for sale in the local market. With the rise of the digital economy, brands now can go global by building a local footprint.

Market Fragmentation

market-fragmentation
Market fragmentation is most commonly seen in growing markets, which fragment and break away from the parent market to become self-sustaining markets with different products and services. Market fragmentation is a concept suggesting that all markets are diverse and fragment into distinct customer groups over time.

L-Shaped Recovery

l-shaped-recovery
The L-shaped recovery refers to an economy that declines steeply and then flatlines with weak or no growth. On a graph plotting GDP against time, this precipitous fall combined with a long period of stagnation looks like the letter “L”. The L-shaped recovery is sometimes called an L-shaped recession because the economy does not return to trend line growth.  The L-shaped recovery, therefore, is a recession shape used by economists to describe different types of recessions and their subsequent recoveries. In an L-shaped recovery, the economy is characterized by a severe recession with high unemployment and near-zero economic growth.

Comparative Advantage

comparative-advantage
Comparative advantage was first described by political economist David Ricardo in his book Principles of Political Economy and Taxation. Ricardo used his theory to argue against Great Britain’s protectionist laws which restricted the import of wheat from 1815 to 1846.  Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country.

Easterlin Paradox

easterlin-paradox
The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.

Economies of Scale

economies-of-scale
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

diseconomies-of-scale
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Economies of Scope

economies-of-scope
An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.

Price Sensitivity

price-sensitivity
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Negative Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

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