To Fight Against the Depression Knocking our Door

<h1>To Fight Against the Depression Knocking our Door</h1>Author: <a title="V P Singh" href="http://www.articlesbase.com/authors/v-p-singh/82954.htm">V P Singh</a>           There are some writers taking very lightly the threat of endangering entrance of another world wide depression. They are of the view that ‘what goes up must come down’. It seems that either they are not aware of the catastrophe and panic of the suspected depression or they are carelessly trying to avoid the worry. Neglecting a problem is no solution. I think, it is due responsibility of thinkers to not only find out the reasons of but also the ways and means to either totally block or at least hamper the entrance of the depression so as to keep the world economies bewared from depression calamity.           To start finding out the probable reasons of the suspected depression knocking our door we will better recall Lord Keynes who gave the irrefutable logic that depression is always caused on account of a lack of ‘effective demand’. The effective demand comprises of consumption demand and investment demand. Therefore, the lack of effective demand may come about due to the lack of either the consumption demand or the investment demand or both. Hence, to increase effective demand the consumption demand or the investment demand or both should be increased.           TO INCREASE CONSUMPTION DEMAND According to Keynes, “The fundamental psychological law upon which we are entitled to depend with great confidence both a priory from our knowledge of human nature and from the detailed facts of experience is that men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income”. Keynes further contends that consumption expenditure is a function of the absolute current income.           That is, Ct = f(Yt)                                --------------(1)           This functional relationship between consumption and income needs further clarification as regards to the concept of income. According to Gardner Ackley, in the absence of some reasonable theoretical basis regarding the dependence of money value of consumption expenditure upon the money value of income, it may well be continued to assume that real income determines real consumption to the extent that income determines consumption. Moreover, Lawrence Klien and J. Margolis, on the basis of their empirical study, held that the consumption expenditure is determined by disposable income more correctly than by total earnings. It was further resolved and concluded that the consumption expenditure (hereinafter referred to as consumption) of an economy is a function of its current real absolute disposable income (hereinafter referred to as income).            The algebraic form of the consumption function (1) above depends upon the nature of consumption curve. It may be linear or non-linear as depending upon the consumption behaviour of the people throughout the variation in income. J. Powelson advocates that it is generally preferred to lay emphasis on linear form of consumption function on account of the fact that it requires rather less detailed and less accurate knowledge of the people’s spending reactions and, moreover, that in short term analysis the linearity and the non-linearity of the consumption function make insignificant difference in the results. That is why Keynes also used the linear form of consumption function in his analysis. Obviously the economists, preferring linear form of consumption function, remained confined to the analysis of the problem of income-consumption relationship for a short term of the order of making insignificant change in the parameters of the economy. But, in the later half of the twentieth century, economic analysis of such a short term has lost its importance since the adoption of economic planning. The economic analysis for a full plan period is most desirable in a planned economy. A single plan period, being generally of the order of five to ten years, is sufficient enough to experience a significant change in the parameters of the economy, especially in case of a developing economy where the entire socio-economic setup is being changed fast on account of rapid economic development through development plans. Therefore, irrespective of the term of analysis either being short to the order of a single plan period or being long enough, the nature or shape of consumption curve must be analogous to the empirical studies and widely acceptable principle of expenditure behaviour of the people.           If the income is increased successively, the consumption decision out of every successive increase in the level of income will determine the ‘marginal propensity to consume’ of the economy. Thus marginal propensity to consume (MPC) is the sole determinant of the true locus of the consumption curve. Therefore, the true shape and nature of the consumption curve will be arrived at by studying the behaviour of MPC throughout the increase in income. As widely accepted, MPC goes on declining at higher levels of income and approaches to zero at a very high level of income where all available consumption goods are included in the consumption schedule in a way that it gives maximum possible satisfaction to the people. Hence, assuming that consumption is never zero at zero level of income, the consumption curve must attain the form of a curve representing an exponential consumption function as given below.                                  -wY           C = Ca + m(1- e          )                      --------------(2)           Where, Ca is autonomous consumption or the minimum consumption. ‘m’ and ‘w’ are constants, i.e. parameters of the function.            In the above function, ‘m’ determines the maximum level to which consumption approaches when income approaches to such a high level where MPC approaches to zero and the people attain maximum possible satisfaction from the available consumption goods. This level of consumption corresponds to such a level of income where not the income but other factors like tastes, habits, fashion, traditions, technology etc. prevent the consumption from increasing. These factors are determined by the entire social, political and religious way of living of the people. Hence, ‘m’ can be regarded as Marxian ‘mode’ of production.           As regards to ‘w’, it contributes to determine slope of the consumption curve within the given range from C = Ca to C = Ca + m. The slope of consumption curve represents MPC and, thence, determines the extent of increase in consumption in response to a unit increase in income (or the rate of change in consumption in response to change in income). This rate of change in consumption, i.e. MPC, depends upon the distribution of income and the conspicuity factors like pride, avarice etc. The distribution of income and the conspicuity factors are both largely determined by class structure of the community. Hence, ‘w’ can be regarded as Marxian ‘relations’ of production.            From the consumption function (2) above, MPC comes out to be as under.                                        -wY            MPC = dc/dy = mwe                         ------------------(3)           If MPC, as expressed in (3), is made use of in the formula pertaining to Keynesian ‘multiplier (K), the modified multiplier formula comes out to become as under.                                 -wY           K = 1/(1 – mwe       )                          ----------------(4)           The modified multiplier formula, as derived above, algebraically prove Keynesian assertion that at higher levels of income the magnitude of multiplier (K) declines whereby, (at higher levels of income) higher doses of investment are required to produce same increase in income. Moreover, at high levels of income, where MPC approaches to zero and ‘K’ thence approaches to unity, the multiplier becomes ineffective making the economy stagnated. To bring about further economic growth, at this stage, the magnitude of multiplier ‘K’ is to be made significantly greater than unity by raising MPC to some positive value. This type of a change in MPC and hence in ‘K’ is possible through either raising the value of ‘m’ or decreasing the value of ‘w’ or both as evident from the expression (3) defining MPC. The value of ‘m’ can be raised by introducing new items in the consumption schedule along with some quality improvement in the existing items. Similarly, the value of ‘w’ can be decreased by mitigating the inequalities in income distribution. In developed economies the conspicuity factors are insignificant. Therefore, the mitigation of income distribution inequalities in developed economy has lesser bearing on increasing MPC than that in developing economies where the income distribution is considerably unequal.            As regards to the present depressive situation in the world economies, the developed economies too are suffering from considerable level of inequalities in income distribution. Therefore, introducing new consumption items, improving quality of existing items and making income distribution more equal will help to increase consumption demand almost equally in both the developed and the developing economies. TO INCREASE INVESTMENT DEMAND            The situation pertaining to induced (productive) investment at present is different in the developing and the developed economies. The developed economies are characterized by more than the desired level of productive investment while the developing economies are still suffering from persistent lack of total investment. Therefore, the developed economies need only to preserve the existing productive investment in the present depressive situation. It can well be done by raising the purchasing power of the middle income group (the dominating group in the consumption goods market) through the measures as suggested for increasing consumption hereinabove. Moreover, the easy consumer loans either free of interest or at an insignificant rate of interest and restriction on speculation (both commodity speculation and non-commodity speculation) activities would be proved most helpful as instant weapons to preserve the existing productive investment. As regards to the developing economies, in the situation of economic depression these economies need not only to preserve the existing productive investment but also to increase it. The Keynesian assertion that ‘induced (productive) investment depends upon the excess of Marginal Efficiency of Capital (the rate of profit earning on investment) over the prevailing rate of interest’ always holds good. Therefore, the developing economies apart from increasing consumption demand as suggested above also have to bring interest rates significantly lower and to increase the ‘Marginal Efficiency of Capital’ (the rate of profit earning on investment) to fight against depression. Among various ways and means of lowering the interest rate the restriction on speculation will help very much in the developing economies because they are always short of capital and the liquidity engaged in speculation not only makes a dent on the supply of capital but also makes the interest rate high.           Moreover the steps taken to mitigate the inequalities of income distribution diverts a part of the flow of income from high income group (the group having insignificant MPC) to the middle income group (the group having high MPC) whereby not only the consumption demand will improve but the magnitude of the multiplier ‘K’ also will attain the value more than unity and become effective in raising income, employment and induced investment. CONCLUSION AND SUGGESTIONS           The above discussion makes amply clear that the situation of world wide depressive economic trend emerging on account of unequal income distribution, large amount of liquidity engaged in speculation activities and saturation in induced investment can well be faced by taking following steps.           1. The income of the middle income group and the low income group should be preserved against unemployment.           2. The inequality of income distribution should be alleviated fast so as to divert a considerable portion of income of the high income group towards the middle income group and the low income group.           3. A wide range of consumer loans at negligible interest rate or interest free should be floated in the market.           4. Government should make its expenditure concentrating on the external economies to the existing production units.           5. Government expenditure (autonomous investment) for attracting new induced (productive) investment should be stopped.           6. A subsidy scheme for the consumption goods should be launched in a way that consumption goods pertaining to high income group may become under the reach of middle income group and consumption goods pertaining to middle income group may become under the reach of low income group.           7. Flow of funds towards trade & commerce enhancement should be restricted.           8. Speculation activities, especially the non-commodity speculation activities should be stopped.                                                 _____________________About the Author: Article Source: <a href="http://www.articlesbase.com/">ArticlesBase.com</a> - <a href="http://www.articlesbase.com/economics-articles/to-fight-against-the-depression-knocking-our-door-623131.html" title="To Fight Against the Depression Knocking our Door">To Fight Against the Depression Knocking our Door</a>

There are some writers taking very lightly the threat of endangering entrance of another world wide depression. They are of the view that ‘what goes up must come down’. It seems that either they are not aware of the catastrophe and panic of the suspected depression or they are carelessly trying to avoid the worry. Neglecting a problem is no solution. I think, it is due responsibility of thinkers to not only find out the reasons of but also the ways and means to either totally block or at least hamper the entrance of the depression so as to keep the world economies bewared from depression calamity.

To start finding out the probable reasons of the suspected depression knocking our door we will better recall Lord Keynes who gave the irrefutable logic that depression is always caused on account of a lack of ‘effective demand’. The effective demand comprises of consumption demand and investment demand. Therefore, the lack of effective demand may come about due to the lack of either the consumption demand or the investment demand or both. Hence, to increase effective demand the consumption demand or the investment demand or both should be increased.

TO INCREASE CONSUMPTION DEMAND According to Keynes, “The fundamental psychological law upon which we are entitled to depend with great confidence both a priory from our knowledge of human nature and from the detailed facts of experience is that men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income”. Keynes further contends that consumption expenditure is a function of the absolute current income.

That is, Ct = f(Yt) --------------(1)

This functional relationship between consumption and income needs further clarification as regards to the concept of income. According to Gardner Ackley, in the absence of some reasonable theoretical basis regarding the dependence of money value of consumption expenditure upon the money value of income, it may well be continued to assume that real income determines real consumption to the extent that income determines consumption. Moreover, Lawrence Klien and J. Margolis, on the basis of their empirical study, held that the consumption expenditure is determined by disposable income more correctly than by total earnings. It was further resolved and concluded that the consumption expenditure (hereinafter referred to as consumption) of an economy is a function of its current real absolute disposable income (hereinafter referred to as income).

The algebraic form of the consumption function (1) above depends upon the nature of consumption curve. It may be linear or non-linear as depending upon the consumption behaviour of the people throughout the variation in income. J. Powelson advocates that it is generally preferred to lay emphasis on linear form of consumption function on account of the fact that it requires rather less detailed and less accurate knowledge of the people’s spending reactions and, moreover, that in short term analysis the linearity and the non-linearity of the consumption function make insignificant difference in the results. That is why Keynes also used the linear form of consumption function in his analysis. Obviously the economists, preferring linear form of consumption function, remained confined to the analysis of the problem of income-consumption relationship for a short term of the order of making insignificant change in the parameters of the economy. But, in the later half of the twentieth century, economic analysis of such a short term has lost its importance since the adoption of economic planning. The economic analysis for a full plan period is most desirable in a planned economy. A single plan period, being generally of the order of five to ten years, is sufficient enough to experience a significant change in the parameters of the economy, especially in case of a developing economy where the entire socio-economic setup is being changed fast on account of rapid economic development through development plans. Therefore, irrespective of the term of analysis either being short to the order of a single plan period or being long enough, the nature or shape of consumption curve must be analogous to the empirical studies and widely acceptable principle of expenditure behaviour of the people.

If the income is increased successively, the consumption decision out of every successive increase in the level of income will determine the ‘marginal propensity to consume’ of the economy. Thus marginal propensity to consume (MPC) is the sole determinant of the true locus of the consumption curve. Therefore, the true shape and nature of the consumption curve will be arrived at by studying the behaviour of MPC throughout the increase in income. As widely accepted, MPC goes on declining at higher levels of income and approaches to zero at a very high level of income where all available consumption goods are included in the consumption schedule in a way that it gives maximum possible satisfaction to the people. Hence, assuming that consumption is never zero at zero level of income, the consumption curve must attain the form of a curve representing an exponential consumption function as given below.

-wY

C = Ca + m(1- e ) --------------(2)

Where, Ca is autonomous consumption or the minimum consumption. ‘m’ and ‘w’ are constants, i.e. parameters of the function.

In the above function, ‘m’ determines the maximum level to which consumption approaches when income approaches to such a high level where MPC approaches to zero and the people attain maximum possible satisfaction from the available consumption goods. This level of consumption corresponds to such a level of income where not the income but other factors like tastes, habits, fashion, traditions, technology etc. prevent the consumption from increasing. These factors are determined by the entire social, political and religious way of living of the people. Hence, ‘m’ can be regarded as Marxian ‘mode’ of production.

As regards to ‘w’, it contributes to determine slope of the consumption curve within the given range from C = Ca to C = Ca + m. The slope of consumption curve represents MPC and, thence, determines the extent of increase in consumption in response to a unit increase in income (or the rate of change in consumption in response to change in income). This rate of change in consumption, i.e. MPC, depends upon the distribution of income and the conspicuity factors like pride, avarice etc. The distribution of income and the conspicuity factors are both largely determined by class structure of the community. Hence, ‘w’ can be regarded as Marxian ‘relations’ of production.

From the consumption function (2) above, MPC comes out to be as under.

-wY

MPC = dc/dy = mwe ------------------(3)

If MPC, as expressed in (3), is made use of in the formula pertaining to Keynesian ‘multiplier (K), the modified multiplier formula comes out to become as under.

-wY

K = 1/(1 – mwe ) ----------------(4)

The modified multiplier formula, as derived above, algebraically prove Keynesian assertion that at higher levels of income the magnitude of multiplier (K) declines whereby, (at higher levels of income) higher doses of investment are required to produce same increase in income. Moreover, at high levels of income, where MPC approaches to zero and ‘K’ thence approaches to unity, the multiplier becomes ineffective making the economy stagnated. To bring about further economic growth, at this stage, the magnitude of multiplier ‘K’ is to be made significantly greater than unity by raising MPC to some positive value. This type of a change in MPC and hence in ‘K’ is possible through either raising the value of ‘m’ or decreasing the value of ‘w’ or both as evident from the expression (3) defining MPC. The value of ‘m’ can be raised by introducing new items in the consumption schedule along with some quality improvement in the existing items. Similarly, the value of ‘w’ can be decreased by mitigating the inequalities in income distribution. In developed economies the conspicuity factors are insignificant. Therefore, the mitigation of income distribution inequalities in developed economy has lesser bearing on increasing MPC than that in developing economies where the income distribution is considerably unequal.

As regards to the present depressive situation in the world economies, the developed economies too are suffering from considerable level of inequalities in income distribution. Therefore, introducing new consumption items, improving quality of existing items and making income distribution more equal will help to increase consumption demand almost equally in both the developed and the developing economies.

TO INCREASE INVESTMENT DEMAND

The situation pertaining to induced (productive) investment at present is different in the developing and the developed economies. The developed economies are characterized by more than the desired level of productive investment while the developing economies are still suffering from persistent lack of total investment. Therefore, the developed economies need only to preserve the existing productive investment in the present depressive situation. It can well be done by raising the purchasing power of the middle income group (the dominating group in the consumption goods market) through the measures as suggested for increasing consumption hereinabove. Moreover, the easy consumer loans either free of interest or at an insignificant rate of interest and restriction on speculation (both commodity speculation and non-commodity speculation) activities would be proved most helpful as instant weapons to preserve the existing productive investment. As regards to the developing economies, in the situation of economic depression these economies need not only to preserve the existing productive investment but also to increase it. The Keynesian assertion that ‘induced (productive) investment depends upon the excess of Marginal Efficiency of Capital (the rate of profit earning on investment) over the prevailing rate of interest’ always holds good. Therefore, the developing economies apart from increasing consumption demand as suggested above also have to bring interest rates significantly lower and to increase the ‘Marginal Efficiency of Capital’ (the rate of profit earning on investment) to fight against depression. Among various ways and means of lowering the interest rate the restriction on speculation will help very much in the developing economies because they are always short of capital and the liquidity engaged in speculation not only makes a dent on the supply of capital but also makes the interest rate high.

Moreover the steps taken to mitigate the inequalities of income distribution diverts a part of the flow of income from high income group (the group having insignificant MPC) to the middle income group (the group having high MPC) whereby not only the consumption demand will improve but the magnitude of the multiplier ‘K’ also will attain the value more than unity and become effective in raising income, employment and induced investment.

CONCLUSION AND SUGGESTIONS

The above discussion makes amply clear that the situation of world wide depressive economic trend emerging on account of unequal income distribution, large amount of liquidity engaged in speculation activities and saturation in induced investment can well be faced by taking following steps.

1. The income of the middle income group and the low income group should be preserved against unemployment.

2. The inequality of income distribution should be alleviated fast so as to divert a considerable portion of income of the high income group towards the middle income group and the low income group.

3. A wide range of consumer loans at negligible interest rate or interest free should be floated in the market.

4. Government should make its expenditure concentrating on the external economies to the existing production units.

5. Government expenditure (autonomous investment) for attracting new induced (productive) investment should be stopped.

6. A subsidy scheme for the consumption goods should be launched in a way that consumption goods pertaining to high income group may become under the reach of middle income group and consumption goods pertaining to middle income group may become under the reach of low income group.

7. Flow of funds towards trade & commerce enhancement should be restricted.

8. Speculation activities, especially the non-commodity speculation activities should be stopped.

_____________________

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Article Tags: Speculation, Effective Demand, Marginal Efficiency Of Capital, Autonomous Consumption, Consumption Function, Autonomous Investment, Marginal Propensity To Consume

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