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Difficulty: EasyCauses of the Great Depression

"We are now buying on credit things that we cannot afford and do not need, and we are paying for them out of future wages that are by no means certain. The rapid expansion of this system of installment purchasing has artificially stimulated demand, but it has also created a mountain of consumer debt that threatens the stability of our entire economic structure."
— Financial analyst warning, 1928

The economic trend described in the excerpt most directly contributed to the onset of the Great Depression by doing which of the following?

  1. A
    Prompting the immediate passage of New Deal legislation that resolved the economic crisis.
  2. B
    Demonstrating that the federal government adhered strictly to laissez-faire policies by refusing to implement any protective tariffs.
  3. Encouraging widespread consumer debt that led to a sharp contraction in consumer purchasing once credit limits were reached.Answer
  4. D
    Compelling the federal government to establish absolute isolationism by ending all diplomatic relations with Europe.

Answer

Encouraging widespread consumer debt that led to a sharp contraction in consumer purchasing once credit limits were reached.
The correct answer is correct because the expansion of installment plans and easy consumer credit in the 1920s artificially inflated demand for consumer goods. Once households reached their credit limits, consumer spending fell dramatically, causing a crisis of underconsumption where manufacturers had excess inventory, leading to production cutbacks and layoffs.

Step-by-Step Solution

1
Analyze the stimulus context to identify the core economic practice described.
The excerpt warns against the dangers of 'installment purchasing' and buying goods on credit using future wages.
Understanding that the stimulus focuses on the 1920s trend of installment plans and consumer credit.
2
Connect consumer credit practices to the macroeconomic events of the late 1920s and early 1930s.
Unrestricted credit artificially increased demand, but once consumer debt peaked, spending dropped rapidly, leading to industrial overproduction and business failures.
Identifying how the end of credit expansion triggered a sudden drop in aggregate demand, starting the economic downturn.
3
Evaluate the choices to find the statement that historically aligns with this chain of events.
The statement about encouraging widespread consumer debt leading to a sharp contraction in purchasing aligns perfectly.
To select the correct option while eliminating choices that misrepresent the timeline (New Deal), tariff history (laissez-faire), or foreign policy (absolute isolationism).

Key Concept

Consumer credit expansion and installment buying as a structural cause of the Great Depression
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Topics

Causes of the Great Depression

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