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The activist-nonactivist controversy originated more than 50 years ago with a debate between John Maynard Keynes and the classical economists who dominated that period. The classical economists felt that a market economy allowed to function without artificial restrictions would provide members of a society with the goods and services they desired while simultaneously maintaining full employment.

The foundation of the classical theory of employment was Say's Law: Supply creates its own demand. More precisely, the act of producing output creates the income that will take that output off the market. Because everything that businesses produce will be sold, there should be nothing to prevent the economy from expanding to full employment.

Even an increase in saving was not considered a problem. The increased availability of loanable funds would cause the interest rate to fall, thereby encouraging businesses to borrow those funds and invest them. If the interest rate somehow failed to equate the plans of savers and investors, wage and price adjustments would compensate for any deficiency in spending. Prolonged unemployment would result only if workers made unreasonable wage demands.

The massive and prolonged unemployment that accompanied the Great Depression cast doubt on the predictions of the classical economists and subjected their model to criticism. The most devastating attack came from John Maynard Keynes. Keynes argued that a market economy does not contain any internal mechanism to ensure full employment. In his view the primary determinant of an economy's health is the level of total spending, or total demand for goods and services. If spending is inadequate, unemployment will result; if it is excessive, inflation will occur.

Keynes believed that it was the responsibility of the federal government to combat unemployment or inflation. This could be accomplished through fiscal policy—the manipulation of government spending and taxation in order to guide the economy's performance—or through monetary policy—policy intended to alter the money supply as a method of influencing total spending and the economy's performance.

Key terms

Equilibrium output. A stable output, one that is

Say's Law. The theory that supply creates its neither expanding nor contracting. own demand. In the process of producing

Injection. An addition to the circular flow of output, businesses create enough income to spending; e.g., investment spending. ensure that all the output will be sold.

Leakage. A subtraction from the circular flow of

Unemployment equilibrium. A stable level of spending; e.g., saving. output that is not large enough to permit full employment.

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