The General Theory Chapter 3 (part six of seven parts)

Again from Guest Blogger BF

The next bit of section 2 of Ch 3 is basically a summary of the general theory of employment.  Let’s just pull a few points from it.

First some notation: in JMK’s terms, D = effective total demand, D₁ is spending on consumption goods and D₂ is spending on investment.  Then D = D₁ + D₂ = φ(N), where φ(N) is aggregate supply (so we’re looking here at a statement of the Keynesian equilibrium condition) and D₁, consumption spending, since it depends on income must also depend on N:  D₁  =  χ(N), which depends on the propensity to consume (note the absence of the term “marginal” here).  Then φ(N) – χ(N) = D₂.  So, in equilibrium, the total level of employment, N, depends on the aggregate supply function, φ, the propensity to consume, ψ, and the volume of investment, D₂.  “This is the essence of the General Theory of Employment”.

We then get a couple of slightly odd sounding (to our ears) statements.  For example, for every value of N, the real wage is determined by the marginal productivity of labour in the wage goods sector.  Remember, in JMK’s model labour negotiates for a money wage, not a real wage, and labour can’t, by taking the initiative and taking cuts to its money wage, cause the real wage to fall to the full employment level.  However, N can’t be any greater than “the value which reduces the real wage to equality with the marginal disutility of labour”.  JMK’s assumptions about wages and labour don’t alter the fact that full employment is at the intersection of the marginal productivity and marginal disutility of labour curves (both measured in money terms).  But if there’s a deficiency of aggregate demand, the real wage will, as a result, lie above the marginal disutility of labour curve.

One other point in this section – JMK assumes that the propensity to save will be greater in a rich community than in a poor one, so that unless the inducement to invest is stronger in the richer community, the principle of effective demand means that its actual level of output will drop until the gap between output and consumption equals the amount it is inclined to invest.  So if the propensity to save is high but the inducement to invest is weak and investment is low, the potentially wealthy community will become poor.

Incidentally, the assumption that the (marginal) propensity to consume declines as income rises is sometimes used to justify a concave Keynesian aggregate demand (i.e. expenditure) curve.  That doesn’t necessarily follow, though.  Higher total income could follow from more people being employed at unchanged average income, with each new hire having the same propensity to consume as the people who already had jobs.

BF