Because of the Great Depression that hit the United States during the early 1930s, Keynes was able to conclude in his work entitled General Theory that institutions of a market economy cannot always attain full-employment equilibrium. While this book was able to provide the basis for researching fluctuations in the economy during the 1940s, the classical economic ideologies remain rooted in competitive equilibrium wherein “competitive” may refer to a monopolistic economy or to one with a perfectly competitive market. While Milton Friedman asserted that “competitive” meant “perfectly competitive,” another issue arose regarding how the word “equilibrium” proved to be more relevant than “disequilibrium.” In this chapter, we look into how models which are based on market equilibrium fall short in explaining short-run fluctuations in output and employment. We explore the real business cycles through applying macroeconomic data to competitive equilibrium dynamic theories.
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