Seriously 2.0

I read Paul Krugman's latest blog entry and had another one of those "stunned silence" moments. He is actually asserting that aggregate macroeconomic demand during the depths of the Great Depression was perfectly inelastic, as he demonstrates with this graph:

Sure, many of us have seen this in theoretical demonstrations during our study of economics. But Mr. Krugman is suggesting that this was a REAL phenomenon during the Great Depression.

"They’re [naysaying, logic-burdened economists] implicitly assuming – not demonstrating – that the AD curve had a 'normal' slope, even in the depths of the Depression. But it didn’t."

Thank you, Mr. Krugman, for using a theoretical demonstration used to teach the concept of demand inelasticity to "prove" that government policies used to boost wages during the depression were actually helpful. Great work.

Let's inject some logic into this and watch it fall apart, shall we? First, let's try to consider a world in which aggregate demand is perfectly inelastic. Imagine, for a moment, that it is 1935, and you are unemployed and extremely poor. You are a bit hungry, and have plenty of choices for something to eat, but you decide you want to buy one orange. You are the proud owner of $1.00, and an orange vendor is happy to sell you oranges for $0.05 each. It strikes you as a reasonable deal.

The basic assumption of perfectly inelastic demand is that the quantity demanded does not change as a result of a change in price. So if Mr. Krugman's assertion about conditions during the Great Depression are correct, then you would still buy one orange, even if it cost you $1.00.

Logic tells me that this would be highly unlikely (or more realistically, impossible) in a marketplace with alternative choices (as existed during the Great Depression, and still exists today). If the orange vendor told you that he would be willing to sell you an orange for $1.00, you are probably more likely to try to find a way to make your dollar last you longer.

But the pomposity of the liberal doesn't end there -- we are not simply talking about the supply and demand conditions for oranges, but the supply and demand conditions for every good and service in the "aggregate" economy. Essentially, buyers are willing to buy the same amount of all goods and services regardless of price.

This does not sound like a realistic condition to me. But Mr. Krugman is happy to muddle up theories regarding interest rates, demand for money, and liquidity, to try to get you to believe that there was no negative effect to artificially boosting wages during the Great Depression (and, one would believe, he is saying the same is true now).

Doesn't it seem more logical, Mr. Krugman, that employers have only a limited amount of money with which they can hire employees? And, perhaps, forcing them to pay each employee more money might force them to discharge some employees in order to cover the new, increased labor cost? It also seems logical, then, that these displaced employees would be less inclined to use any savings they have to purchase the same amount of goods and services. It is even feasible to assume that some employers would not be able to lay off enough workers to continue production, and as a result, would have to raise prices instead (thereby reducing quantity demanded for their product). It is not out of the realm of possibility that this could drive companies who were employing numerous workers out of business entirely.

Again, Mr. Krugman; but this time, with more logic.