QUESTION 2
Recall that an economic depression can occur due to an excess demand for money, which is identified also by an excess supply of goods. This can occur when:
The quantity of money increases
The quantity of money decreases
The velocity of money increases
Long-run potential income falls
To analyze the causes of an economic depression, we need to understand the relationship between money supply, goods supply, and the overall economy. In this case, an economic depression occurs when there is an excess demand for money, which is also identified by an excess supply of goods. This situation can arise from several factors:
1. The quantity of money increases: If the central bank or financial institutions increase the money supply rapidly without a corresponding increase in goods and services production, it can lead to a situation where there is more money in circulation than people need or want to spend. This excess demand for money can result in a decrease in the demand for goods, leading to a decrease in production and overall economic activity.
2. The quantity of money decreases: Conversely, if the money supply decreases significantly, people may become reluctant to spend due to fear of shortage or uncertainty about the future. This decrease in money supply can lead to a decrease in the demand for goods, causing businesses to reduce production and resulting in an economic depression.
3. The velocity of money increases: The velocity of money measures how quickly money circulates through the economy. If people start to spend money at a faster rate, it can create an initial boost in economic activity. However, if the increase in spending exceeds the capacity of the economy to produce goods and services, it can create an imbalance between the supply of goods and the amount of money available. This excess demand for goods can eventually lead to an economic downturn.
4. Long-run potential income falls: A decrease in long-run potential income refers to a decline in an economy's capacity to produce goods and services. This can result from factors such as a decrease in productivity, a decline in investment, or a lack of technological progress. When the economy's capacity to produce goods and services is reduced, it can contribute to an excess supply of goods relative to the demand, leading to decreased production and an economic depression.
In summary, an economic depression can occur due to an excess demand for money, which is identified by an excess supply of goods. This can result from various factors, including changes in the quantity of money, velocity of money, and long-run potential income.