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