| Principle | What it Means | Why It Matters | |-----------|---------------|----------------| | **Demand‑driven output** | The level of production and employment is primarily set by the total demand for goods and services. | If demand falls, output and employment drop; if it rises, the economy expands. | | **Multiplier effect** | An initial change in spending (e.g., government investment) leads to a larger overall change in income and output. | Small fiscal actions can have outsized impacts on the economy. | | **Liquidity preference** | People prefer to hold cash (liquidity) over other assets, especially during uncertainty. | Interest rates adjust to balance savings and investment. | | **Fiscal policy as a tool** | Governments can influence demand through taxes and spending. | Counter‑cyclical measures (stimulus during recessions, austerity during booms) help stabilize the economy. | | **Monetary policy as a complement** | Central banks control the money supply and interest rates to influence investment and consumption. | Lower rates encourage borrowing and spending; higher rates curb inflation. | | **Short‑run focus** | In the short term, prices and wages are sticky, so output can deviate from full employment. | Policy must address these rigidities to avoid prolonged unemployment. |

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• **Great Depression (1929‑1939)**: Traditional classical economics failed to explain persistent unemployment. Keynes argued that insufficient aggregate demand caused the crisis.
• **Keynes’s landmark work**: *The General Theory of Employment, Interest and Money* (1936) introduced the concepts above.
• **Post‑WWII adoption**: Many Western governments adopted Keynesian policies, especially during the 1950s‑1970s, to maintain full employment and moderate inflation.
• **Critiques & evolution**: Monetarists (e.g., Milton Friedman) and later New Classical economists challenged Keynesianism, leading to the development of New Keynesian models that incorporate micro‑foundations and price/wage stickiness.

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| Tool | How It Works | Typical Use | |------|--------------|-------------| | **Government spending** | Direct injection of funds into infrastructure, education, etc. | Stimulate demand during recessions. | | **Tax cuts** | Increase disposable income, encouraging consumption and investment. | Boost demand when private sector is weak. | | **Automatic stabilizers** | Unemployment benefits, progressive taxes that adjust automatically with economic cycles. | Provide a safety net without new legislation. | | **Monetary easing** | Lowering policy rates, quantitative easing. | Make borrowing cheaper, encourage spending. | | **Interest‑rate policy** | Adjusting short‑term rates to influence longer‑term rates and investment. | Control inflation and support growth. |

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