Tag: fallacy of composition

Many politicians throughout the world,














  5. What accelerator effects would you expect from infrastructure investment?

A bumper harvest should be good news for farmers – but not if it drives down prices. This is the position facing many Australian farmers. After a relatively wet summer a year ago and a mild winter this year, crop yields have soared. But the prices farmers can get in wholesale markets have been so low that many have resorted to setting up their own farm shops or selling in farmers’ markets or from the backs of ‘utes’ (utility vehicles, i.e. pickup trucks) or at roadside stalls.

And the supply problem is not just one of increased domestic supply: cheap food imports, often of inferior quality, have been flooding into Australia. Increasing food exports, especially to Asia, would help Australian farmers, but here again there is competition in these markets from other countries.

The problem of increased Australian supply is even more serious for Australian farmers in areas where harvests have not been so good. Australia is a huge country and conditions, although generally favourable this year, have been poor in some areas. Here farmers face the double disaster of low output and low prices.

Australian dairy farmers too are facing problems of falling prices. Price deregulation and the monopsony power of supermarkets have driven down the price of milk and other dairy products. Since deregulation in 2000, the number of dairy farms has halved, as many smaller family farms go out of business and larger ‘industrial-scale’ farms grow.

So are there any solutions? The BBC article looks at things being done in Tasmania to help small farmers, but questions whether small farmers have much of a future more generally in Australia?


Australia’s small farmers struggling with low prices BBC News, Phil Mercer (31/10/13)
Commodity prices edge lower in October Sky News Australia (1/11/13)
Low prices spoil perfect season for Australian farmers ABC News, Eric Tlozek and Courtney Wilson (18/9/13)
Agri-businesses taking over the farm The Guardian (Australia) (6/11/13)


Commodity prices Index Mundi
Agriculture in Australia Wikipedia
Farm inputs & costs Dairy Australia


  1. How does the fallacy of composition relate to the ‘problem’ of good harvests?
  2. How price elastic is the demand for specific crops likely to be? Why may individual farmers face an elasticity of demand close to infinity?
  3. Illustrate the problem for small farmers in Australia with a demand and supply diagram.
  4. Is there any way in which farmers, either individually or collectively, can make their demand less elastic?
  5. Comment on the following statement by a sugar cane farmer: “We’ve got that much money tied up (in the business) we just can’t walk away”. Under what circumstances would it make sense to ‘walk away’?
  6. How does the monopsony power of supermarkets influence the prices farmers receive?
  7. Discuss ways in which the federal government in Australia could support farmers.













Lobster’s worth shelling out for The Observer,
Rachel Cooke (21/9/13)



Here are a series of videos examining the case for and against austerity policy. Is such policy necessary to re-balance countries’ economies and retain or regain the confidence of investors? Or does such policy harm not just short-run growth but long-run growth too? Does it reduce investment and thereby aggregate supply?

These videos follow on from the news item Keynes versus the Classics: a new version of an old story. In the first video, Mark Blyth, author of Austerity: the History of a Dangerous Idea, argues that austerity policy has not worked and never can. George Osborne, by contrast, argues that although it has been a ‘hard road to recovery’, austerity policy is working.

International bodies take a more nuanced stand. The IMF, while supporting the objective of reducing the government deficit, argues that the pace of the cuts in the UK should be slowed until more robust growth returns. The OECD, in examining the global economy, is more supportive of countries maintaining the pace of deficit reduction, but argues that the ECB needs to take stronger monetary measures to boost bank lending in the eurozone.

With austerity having increasingly alarming effects on unemployment and social cohesion, especially within certain eurozone countries, such as Greece, Portugal and Spain, it is not surprising that there are growing demands for rethinking macroeconomic policy.

There is general agreement that more needs to be done to promote economic growth, and a growing consensus that an increase in infrastructure expenditure is desirable. But whether such expenditure should be financed by increased borrowing (with the extra deficit being reduced subsequently as a result of the extra growth), or whether it should be financed by reductions in expenditure elsewhere, is a continuing focus of debate.

Austerity: the History of a Dangerous Idea The Guardian, Mark Blyth (27/5/13) (see also)
IMF: UK austerity will be a ‘drag on growth’ BBC News. Hugh Pym (22/5/13)
George Osborne: ‘Hard road to recovery for UK economy’ BBC News (22/5/13)
Economy and austerity BBC News, Sajid Javid and Stephen Timms (1/5/13)
IMF’s Olivier Blanchard urges UK austerity rethink BBC News (16/4/13)
OECD ‘supportive of Osborne austerity plans’ BBC news (29/5/13)
Stimulus vs. austerity measures in EU CNN, Mohamed El-Erian (29/5/13)
‘No time to wobble’ on deficit reduction YouTube, Sir Roger Carr (CBI president) (16/5/13)
Deficit-Cutting: Not If, But When Wall Street Journal Live, David Wessel (8/5/13)


  1. What are the arguments for maintaining a policy of deficit reduction through tight fiscal policy?
  2. What are the three principles put forward by Mark Blyth for designing an appropriate macroeconomic policy?
  3. How does the fallacy of composition relate to the effects of all countries pursuing austerity policy simultaneously?
  4. Is the IMF for or against austerity? Explain.
  5. Assess the policies advocated by the OECD to stimulate economic growth in the eurozone.

The ‘Classical’ Treasury view of the 1920s and 30s was that extra government spending or tax cuts were not the solution to depression and mass unemployment. Instead, it would crowd out private expenditure if the money supply were not allowed to rise as it would drive up interest rates. But if money supply were allowed to rise, this would be inflationary. The solution was to reduce budget deficits to increase confidence in public finances and to encourage private investment. Greater price and wage flexibility were the answer to markets not clearing.

Keynes countered these arguments by arguing that the economy could settle in a state of mass unemployment, with low confidence leading to lower consumer expenditure, lower investment, lower incomes and lower employment. The situation would be made worse, not better, by cuts in public expenditure or tax rises in an attempt to reduce the budget deficit. The solution was higher public expenditure to stimulate aggregate demand. This could be achieved by fiscal and monetary policies. Monetary policy alone could, however, be made ineffective by the liquidity trap. Extra money might simply be held rather than spent.

This old debate has been reborn since the financial crisis of 2007/8 and the subsequent deep recession and, more recently, the lack of recovery. (Click here for a PowerPoint of the chart.)

The articles below consider the current situation. Many economists, but certainly not all, take a Keynesian line that austerity policies to reduce public-sector deficits have been counter-productive. By dampening demand, such policies have reduced national income and slowed the recovery in both investment and consumer demand. This has at best slowed the rate of deficit reduction or at worst even increased the deficit, with lower GDP leading to a reduction in tax receipts and higher unemployment leading to higher government social security expenditure.

Although monetary policy has been very loose, measures such as record low interest rates and quantitative easing have been largely ineffective in stimulating demand. Economies are stuck in a liquidity trap, with banks preferring to build their reserves rather than to increase lending. This is the result partly of a lack of confidence and partly of pressure on them to meet Basel II and III requirements of reducing their leverage.

But despite the call from many economists to use fiscal policy and more radical monetary policy to stimulate demand, most governments have been pre-occupied with reducing their deficits and ultimately their debt. Their fear is that rising deficits undermine growth – a fear that was given weight by, amongst others, the work of Reinhart and Rogoff (see the blog posts Reinhart and Rogoff: debt and growth and It could be you and see also Light at the end of the tunnel – or an oncoming train?.

But there is some movement by governments. The new Japanese government under Shinzo Abe is following an aggressive monetary policy to drive down the exchange rate and boost aggregate demand (see A J-curve for Japan?) and, more recently, the European Commission has agreed to slow the pace of austerity by giving the Netherlands, France, Spain, Poland, Portugal and Slovenia more time to bring their budget deficits below the 3% of GDP target.

Of course, whether or not expansionary fiscal and/or monetary policies should be used to tackle a lack of growth does not alter the argument that supply-side policies are also required in order to increase potential economic growth.

A Keynesian Victory, but Austerity Stands Firm The New York Times, Business Day, Eduardo Porter (21/5/13)
With Austerity Under Fire, Countries Seek a More Balanced Solution Knowledge@Wharton (22/5/13)
Keynes, Say’s Law and the Theory of the Business Cycle History of Economics Review 25.1-2, Steven Kates (1996)
Is Lord Keynes back in Brussels? The Conversation, Fabrizio Carmignani (31/5/13)
Keynes’s Biggest Mistake The New York Times, Business Day, Bruce Bartlett (7/5/13)
Keynes’s Not So Big Mistake The New York Times, The Conscience of a Liberal blog, Paul Krugman (7/5/13)
The Chutzpah Caucus The New York Times, The Conscience of a Liberal blog, Paul Krugman (5/5/13)
Keynes and Keynesianism The New York Times, Business Day, Bruce Bartlett (14/5/13)
Japan Is About To Prove Keynesian Economics Entirely Wrong Forbes, Tim Worstall (11/5/13)
The poverty of austerity exposed Aljazeera, Paul Rosenberg (24/5/13)
Britain is a lab rat for George Osborne’s austerity programme experiment The Guardian, Larry Elliott (26/5/13)
Eurozone retreats from austerity – but only as far as ‘austerity lite’ The Guardian, Larry Elliott (30/5/13)
Europe’s long night of uncertainty Daily Times (Pakistan), S P Seth (29/5/13)
Abenomics vs. bad economics The Japan Times Gregory Clark (29/5/13)
European countries to be allowed to ease austerity BBC News (29/5/13)
U.K. Should Restore Growth, Rebalance Economy IMF Survey (22/5/13)
Now everyone is a Keynesian again – except George Osborne The Observer, William Keegan (2/6/13)
Austerity Versus Growth (III): Fiscal Policy And Debt Sustainability Social Europe Journal, Stefan Collignon (30/5/13)


  1. Explain what is meant by Say’s Law and its implication for macroeconomic policy.
  2. Why have many governments, including the UK government, been reluctant to pursue expansionary fiscal policies?
  3. What is meant by the liquidity trap? What is the way out of this trap?
  4. In the first article above, Eduardo Porter argues that ‘moral views are getting in the way of reason’. What does he mean by this?
  5. Explain what are meant by the ‘paradox of thrift’ and the ‘fallacy of composition’. How are these two concepts relevant to the debate over austerity policies?
  6. What are the dangers in pursuing aggressive Keynesian policies?
  7. What are the dangers in not pursuing aggressive Keynesian policies?