Comment: One way to approach this...

(See in situ)

In reply to comment: I love the broken window fallacy (see in situ)

One way to approach this...

...is to ask why there are ever idle factors of production in the first place.

The Keynesians attribute the business cycle to some murky force (e.g. "animal spirits") deep within the capitalist system - but this is just another way of saying they have no clue what causes the business cycle.

The Austrian explanation, on the other hand, is that artificially low interest rates encourage business expansion, which proves unprofitable when interest rates inevitably rise, and this precipitates bankruptcies and the bust phase. If this is correct, then the Keynesian "cure" for depressions is unnecessary, since we can prevent depressions from ever happening in the first place by preventing central banks from interfering in the credit markets.

But supposing there's already a depression underway, could the Keynesians be right that stimulus is necessary to put idle factors of production back to work? No, and here's why.

Every factor of production has what we call a marginal physical product: i.e. the additional quantity of product which its employment would yield. For example, suppose I can hire 1 additional labor-hour and thereby produce 4 additional widgets. The marginal physical product of that 1 labor-hour is thus 4 widgets. Multiply the marginal physical product by the sale-price of the product and you get marginal revenue product. Suppose widgets are selling for $3 each; then the marginal revenue product of that 1 labor-hour is $12. Thus, if I can hire 1 labor-hour for less than $12, I will, because I will make a profit doing so. If I can't get the labor-hour for less than $12, then I won't hire it, because in doing so I would take a loss. Very simple.

The only reason that a factor of production would be sitting idle is if it were priced above its marginal revenue product.

But in a free market, factors of production should never be sitting idle for any extended period of time. If a factor were sitting idle with no one wanting to buy it, its price would fall until it dropped below its marginal revenue product, at which point it could be profitably employed - and so it would draw buyers. Chronic underemployment of the factors of production is always a creature of government intervention in the market, not something which just occurs naturally in the free market.

So, to conclude, the best thing to do is to avoid depressions altogether by avoiding the credit expansions which cause them. The next best thing, if a depression occurs, is for the State to do nothing - or, better yet, to shrink and try to free the market as much as possible. Compare the Great Depression, where the State did everything imaginable, with the Depression of 1920, where the State did nothing and actually shrank. One lasted for over a decade, the other was so brief it's hardly known today.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."