In economic theory, a market consists of sellers and buyers of a good. Typically supply of the good will be available at a price that buyers are willing to pay, so that supply is matched by demand. Economists have advanced a wide variety of theories related to markets. Microeconomics uses mathematics to study consumer behavior with a starting point in a stylized, rational individual attempting to maximize their utility under budget and other constraints. Macroeconomists study the effects of taxation, fiscal policy, and other factors influencing supply and demand on a larger scale.
Keynesian theory proposes remedies for market failures where there exists a mismatch between supply and demand. Based on the writings of John Maynard Keynes, a British economist, Keynesian theories emphasize the way governments through fiscal policy can stimulate demand to counter economic downturns.
Say's Law, formulated by the Frenchman Jean-Baptiste Say at the beginning of the 1800s, states that the value-added in producing a good creates the need for another good or, simply put, supply creates demand. Critics of Say's Law have countered that producers may choose to save rather than spend their earnings.
If fiscal policy results in government expenditures exceeding revenues, public debt will grow accordingly. Governments can decrease their deficits by raising taxes, which directly offsets shortfalls, or issuing bonds. The latter course of action is widely criticized for placing the burden of reducing deficits on coming generations.
Monetary policy influences the economy chiefly through the manipulation of interest rates. Banks are usually required to hold large deposits with central banks that accrue interest at a rate set by the bank, while mortgage companies and other lenders adjust their rates accordingly. Recently, the Federal Reserve and some central banks in other countries have expanded monetary policy and resorted to quantitative easing, a process that increases liquidity chiefly by repurchasing previously issued government debt.
To counter a recession, a government following a Keynesian approach would increase its expenditures on for example infrastructure to increase incomes and demand. Say's Law would dictate that suppliers be supported in order to increase demand. Monetary policy could be mobilized in the form of lower interest rates, enabling firms to replenish their capital.
A fractional reserve banking system is one in which banks only keep a fraction of customer's deposits on hand while lending the rest out. The banks rely on their customers not withdrawing their funds at the same time in a bank run. The loans they issue have the effect of increasing the money supply, but this does not affect wealth as the increase is in the form of debt.