The Broken Window Fallacy With Answer Key

Name:______

Activity: The Broken Window Fallacy

1. Use your knowledge of the Broken Window Fallacy to evaluate the following hypothetical government policies to help pull the economy out of a recession. Please state whether you think this is a good or bad idea and why.

A. In order to reduce unemployment and stimulate the economy, I propose that we hire all of the unemployed people as government workers and pay half of them to dig holes and the other half to fill them back up. This way everyone who wants a job can have one!

B. Things are really bad. A lot of people are out of work, and the price of agricultural commodities is so low that farmers are having a difficult time earning a reasonable income. To help struggling farmers, I propose that the government pay them to destroy a portion of their livestock and crops, making them unfit for human consumption. This will reduce the supply of these products and raise their price, which will help farmers make and eventually spend more money, thus, stimulating the economy!

C. The unemployment rate is high and we need to stimulate the economy. I propose that we use tax dollars to pay car dealers to destroy older used cars by smashing them and sending them to the dump. This will cause people to buy new cars which will increase economic activity and put us on the path to recovery!

2. Please evaluate the statement below made by Paul Krugman a few days after the 2001 terrorist attacks on the World trade Center and the Pentagon. Based on your knowledge of the Broken Window Fallacy, do you think Dr. Krugman is right? Are acts of war and terrorism potentially good for the economy? Why or why not?

“Ghastly as it may seem to say this, the terror attack -- like the original day of infamy, which brought an end to the Great Depression -- could even do some economic good….the destruction isn't big compared with the economy, but rebuilding will generate at least some increase in business spending.” – New York Times article published on September 14th, 2001 by Paul Krugman, a Nobel Prize winning economist. Activity: The Broken Window Fallacy (Answer Key)

3. Use your knowledge of the Broken Window Fallacy to evaluate the following hypothetical government policies to help pull the economy out of a recession. Please state whether you think this is a good or bad idea and why.

According to the Keynesian Economic philosophy which has become popular in recent years during times of economic recession, a policy such as this might make sense as it would employ people and give them money to spend which would stimulate the economy. However, under such a policy nothing is being produced and the money that was spent on employing people to produce nothing could be spent by people in the private sector on producing goods and services that people value, which would increase people’s living standards.

This is actually a real policy employed by the government to help raise crop prices during the Great Depression. In 1933, at a time when the economy was in serious economic trouble and people were going hungry for lack of food, Congress passed the Agricultural Adjustment Act and paid farmers to plow under and destroy portions of their crops, spray potatoes with dye, and slaughter cattle, sheep, and pigs in ways to make them unfit for human consumption. While this policy may have helped some farmers achieve higher prices, it destroyed valuable resources and made the country poorer.

This is another real policy, known as Cash for Clunkers, enacted in 2009 to combat the recent economic decline. Car dealers were paid $3,500 - $4,500 to destroy the older cars that were traded in when customers purchased a new automobile. Dealers were required to ruin the engine with a sodium silicate solution, and the smash the cars and send them to the junkyard so that the parts would not be available for future use. The idea was to stimulate the economy by encouraging people to buy new cars, but every dollar spent on new cars was a dollar that could not be spent elsewhere, so it just shifted spending from other industries to the automobile industry rather than create additional spending (the policy provided 3 billion taxpayer dollars as subsidies for new car purchases). Furthermore, $700,000 used cars valued at $2 billion were destroyed and the price of used cars increased because of the reduced supply. Additionally, new car sales plummeted as soon as the program expired.

4. Please evaluate the statement below made by Paul Krugman a few days after the 2001 terrorist attacks on the World trade Center and the Pentagon. Based on your knowledge of the Broken Window Fallacy, do you think Dr. Krugman is right? Are acts of war and terrorism potentially good for the economy? Why or why not?

The money, time, and effort that was used to clean up and replace the damage caused by the destruction of the World Trade Center could have been used to produce other things so that at the end of the day we could have both the World Trade Center and whatever else could have been produced, as opposed to just the cleaning up of the mess caused by these destructive acts. In other words, once again, spending was not create but just shifted and at the end of the day we have less than we could have if these things did not occur. Apparently, even Nobel Prize Winning economists fall prey to the Broken Window Fallacy.

If you do think destructive acts are good for the economy then ask if it stands to reason that we should fly more planes into buildings whenever we experience an economic recession.