Keynesian Analysis

C

According to Keynes, the major source of business instability is fluctuations in aggregate demand.

Thus, policies that effectively stabilize aggregate demand substantially reduce economic instability.

Keynesian analysis is a macroeconomic theory associated with the ideas of British economist John Maynard Keynes. It focuses on the role of aggregate demand in influencing economic activity and suggests that fluctuations in aggregate demand are an important source of economic instability. Therefore, the correct answer is C. "Fluctuations in aggregate demand are an important source of economic instability."

Keynesian analysis suggests that the level of aggregate demand, which represents the total spending in the economy, is a key determinant of economic output, employment, and inflation. According to Keynesian theory, changes in aggregate demand can result in periods of economic expansion (booms) or contraction (recessions).

Keynes argued that during times of economic downturns or recessions, the private sector may not spend enough to maintain full employment. This could lead to a situation of unemployment and low economic output. In such cases, Keynesian analysis suggests that the government should step in and use fiscal policy measures to stimulate aggregate demand. This can be done through increased government spending or tax cuts to boost consumption and investment.

On the other hand, during periods of economic expansion or inflationary pressures, Keynesian analysis suggests that the government should implement contractionary fiscal policies to reduce aggregate demand and prevent overheating of the economy. This may involve reducing government spending or increasing taxes to cool down the economy and prevent inflation.

Keynesian analysis also challenges the notion of flexible wages and prices quickly directing a market economy to full employment, which is option A. According to Keynes, wages and prices are not flexible enough to ensure rapid adjustments to restore full employment. He argued that rigidities in the labor market and other factors can lead to persistent unemployment even when there are available resources and demand for goods and services.

Option B, stating that the federal budget should be balanced annually, is not a direct implication of Keynesian analysis. While Keynes did emphasize the importance of fiscal policy, including government budget deficits during economic downturns, he did not specifically advocate for an annual balanced budget. Keynesian theory suggests that fiscal policy should be used counter-cyclically, meaning that deficits can be appropriate during recessions to stimulate demand but should be balanced or surplus during periods of economic expansion.

Option D, stating that fluctuations in the money supply are the major source of economic instability, does not align with Keynesian analysis. While monetary policy, which involves the control of the money supply, plays a role in macroeconomic management, Keynesian analysis emphasizes the importance of fiscal policy and aggregate demand in influencing economic activity. Fluctuations in the money supply alone are not considered the major source of economic instability in Keynesian theory.

In summary, Keynesian analysis implies that fluctuations in aggregate demand are an important source of economic instability. It suggests that government intervention through fiscal policy measures can help stabilize the economy during periods of recession or inflationary pressures.