Supply can still matter. In a world of unemployed resources, imagine a company called Apple invents a device called — improbably — an iPad. That's a positive supply shock. People will be led to spend more money. The inventors and their employees will have more money to spend. There will be a positive multiplier throughout the economy, as analyzed by W.H. Hutt. First aggregate supply went up and then aggregate demand went up. It's all one step on the way to economic recovery.
Starting with insufficient aggregate demand does not cut off this process. Starting with a liquidity trap, in contrast, would prevent this multiplier from picking up any steam, if you could sell the iPads in the first place that is.
One bottom line is that aggregate supply still matters when aggregate demand is insufficient. Another lesson is that positive supply developments can increase output and employment.
Tyler, you have omitted a little detail in your explanation. What do you mean when you say “people will be lead to spend more money”? Do you mean that they will use something called money that they have under the mattress? Do you mean that they will spend less in tomatos or cards or machines or lawyer services? Do you mean that they borrow money to buy iPads? but then how lenders will fund the loans or why they will reallocate funds?
More important, you didn’t say in your example if Apple produced its new product by reallocating resources or by employing idle resources. Do you think that you need the concept of aggregate demand to explain what happens in the economy when a new product is introduced? Do you think that whenever resources first become idle –for whatever reasons– and then some entrepreneurs find new ways to use them –a second shock follows the first one– can be analyzed with your “theory”? Don’t you think that that is what usually happens in a market economy? More important, when is a shock a shock, in the sense of being something that you can seriously assume to be exogenous? Or how do you justify your choice of exogenous variables?
I look forward to your answers because I taught your “theory” for many years but then I convinced myself that I was just teaching national accounting (when teaching the theory I didn’t need to refer to the shortcomings of national accounting and I could use the concepts ambiguously). The point is that after more than 40 years your macro theory still lacks both micro foundations and a sound theory of banks as suppliers of different services (at least payments services and financial intermediation services).
I agree with the above comments with one caveat:
Says law may work with respect to those who have sufficient assets such that they do not discontinue purchasing other products when they purchase a new product: in other words, the very wealthy.
You can see evidence of this in the luxury goods market: it crashed, and is roaring back faster than other consumr industries.
Why is this?
Well, it takes just a seed of a few conspicuous consumers to create a cascade of purchasing by those who, with cash, seek to emulate them. The nervous, middle class emulators are not active, but the wealthy emulators never disappeared.
Isn’t the Keynesian crux that Apple would not develop the iPad because of low aggregate demand? If not then I don’t understand it at all.
So, is the point here that Apple can meet a demand that others cannot due to the low demand? But why Apple? That sounds awfully micro/structural to me.
And is the real business of a business in a down-turn to sop up the best engineers, et. al.? This is of course hard to do when competing with the government’s unemployment benefits and stuff.
Re: This is of course hard to do when competing with the government’s unemployment benefits and stuff.
If you’re talking about hiring skilled workers it’s very easy for business to outcompete unemployment benefits: even the best-paying state offers only a poverty level income in UI payments. What business only pays, say, 15K with no benefits to an experienced engineer? Even at a modest salary of 45K with the usual middle class benefits there’s no competition at all: the unemployed engineer will jump at the opportunity.
I would say it less about supply than investment to create that supply although there is plenty of surplus created to undertake more investment. What is needed is enough opportunities and entrepreneurs to believe in and take advantage of them.
It seems unlikely that iPad sales would shift demand away from other products, for the reason that college educated white people (people most likely to buy iPad’s) aren’t suffering much. This group is more likely to have the excess cash or credit to spend on iPad’s without sacrificing other purchases. It would mean their demand for cash just went down by an amount equal to the price of an iPad.
Does anyone else read this blog strictly to see what E. Barandiaran has to say?
I look out for other commenters too. Good to see Nick Rowe here.
Isn’t the Keynesian crux that Apple would not develop the iPad because of low aggregate demand? If not then I don’t understand it at all.
No, development is driven by expected future demand. Spending necessary to prepare for that demand is part of I, a component of current AD.
I just invented a machine that I’m selling for $20 that will turn piles of dirt into any kind of food you want.
Is that a “supply shock”? Come on.
But why not state openly the whole polemic point of the anti-Keynesianism developed by Schumpeter’s student David McCord Wright. His point was that the salvific positive supply shock would only be forthcoming as long as aggregate demand was not artificially propped up. The depression in aggregate demand was putatively necessary to induce the scrapping of capital and to reduce raw material and other prices so as to motivate new investment. So investment in new capital goods in which technological progress will be embodied is predicated on letting the recession do its work of liquidation (old capital goods have to be scrapped, inefficient firms have to go down to create the market room for the stronger firms to have the market room to justify the new investments), and the recessionary phase should therefore be unhindered by demand stimulus, protectionist policy and minimum wage laws. But even Richard Posner knows that the resultant instability would so dim future prospects that the salvific investments and positive supply shock would not be forthcoming. He has become a Keynesian while still assuring us that the real economy is in itself fundamentally sound (he claims that there would have be no great crisis if not for violation of the Taylor Rule and the government sanction of overcompetition in the banking sector).
This argument illustrates the perils of doing macroeconomic theory without data. Even if Tyler is correct about the directionality of all of the effects described, there’s no way to tell which effects will dominate without some measurement of their magnitude.
@Bubble Meter Blog
Um, no.
Tyler’s point was the a supply shock – “the Ipad” – can induce people to increase Consumption and lead us out of a liquidity trap.
As many people have pointed out, this is only the case if people simply do not substitute one good for another – e.g. buying an Ipad instead of a Kindle and a pair of headphones. There is no reason to believe that OVERALL consumption in the economy will be significantly impacted by this new product.
Your point that U-6 is 17.5%, and everyone else could *potentially* purchase this product is completely trivial and irrelevant. We knew this already.
It doesn’t detract from the point that the 82.5% who are employed may not increase consumption from depressed levels because of this single product launch. For all you know, they may buy the Ipad and not buy something else.. even if they are going along at pre-recession levels of Consumption.
Now I’m confused. I always thought the Keynesian multiplier operated by stimulating I. If I increases regardless of a stimulus, wouldn’t the end result be an increase in consumption, as Tyler argues? That or there is no multiplier, and increased consumption does nothing.
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