2013년 1월 31일 목요일

[발췌: 일반이론 3장] The Principle of Effective Demand

출처: The General Theory of Employment, Interest and Money (Keynes, 1936)
자료: MIA(html); eBook; single PDF; Gutenberg.au (cf. my catalog of his writings; 차례/일반이론 독서메모)

※ This is a reading note with excerpts taken and with personal annotations and remarks added in trying to understand the above text, so visit the source links to see the original.

※ 발췌(excerpts):


Chapter 3_ The Principle of Effective Demand

I

[P1] We need, to start with, a few terms which will be defined precisely later. In a given state of technique, resources, and costs, the employment of a given volume of labour by an entrepreneur involves him in two kinds of expense: 
  • first of all, (a) the amount which he pays out to the factors of production (exclusive of other entrepreneurs) for their current services, which we shall call the factor cost of the employment in question; 
  • and secondly, (b1) the amounts which he pays out to other entrepreneurs for what he has to purchase from them together with (b2) the sacrifice which he incurs by employing the equipment instead of leaving it idle, which we shall call the user cost of the employment in question.[1] 
The excess of the value of the resulting output over the sum of its factor cost and its user cost is the profit or, as we shall call it, the income of the entrepreneur. 
  1. The factor cost is, of course, the same thing, looked at from the point of view of the entrepreneur, as what the factors of production regard as their income. Thus the factor cost and the entrepreneur's profit make up, between them, what we shall define as the total income resulting from the employment given by the entrepreneur.
  2. The entrepreneur's profit thus defined is, as it should be, the quantity which he endeavours to maximise when he is deciding what amount of employment to offer.
  3. It is sometimes convenient, when we are looking at it from the entrepreneur's standpoint, to call the aggregate income[=total income](i.e. factor cost plus profit) resulting from a give amount of employment the proceeds of that employment
  4. On the other hand, the aggregate supply price[2] of the output of a given amount of employment is the expectation of proceeds which will just make it worth the while of the entrepreneurs to give that employment.[3]
(4) aggregate supply price: ‘(...) which will just make it worth the while of the entrepreneurs to give that employment’는 이렇게 읽을 수도 있다: ‘(...) which the entrepreneurs should get as a minimum results(i.e. revenue) from that employment through the sale of the output’. 말하자면 기업가가 금기 동안 고용을 이만큼 하기로 결정해 생산을 가동한다면 그 기간 동안 수지를 맞추기 위해 벌어들여야 할 최소한의 수입(매출)이고, 달리 보면 한계비용 곡선의 적분 면적과도 비슷하다.
  • [주2] Not to be confused (vida infra) with the supply price of a unit of output in the ordinary sense of this term. 
  • [주3: 첫 문단 전체의주석] The reader will observe that I am deducting the user cost both from the proceeds[total income or aggregate income] and from the aggregate supply price of a given volume of output, so that (1) both these terms are to be interpreted net of user cost; whereas (2) the aggregate sums paid by the purchasers are, of course, gross of user cost. The reasons why this is convenient will be given in Chapter 6. 
  • [주3: 계속] The essential point is that the aggregate proceeds and aggregate supply price net of user cost can be defined uniquely and unambiguously; whereas, since user cost is obviously dependent both on the degree of integration of industry and on the extent to which entrepreneurs buy from one another, there can be no definition of the aggregate sums paid by purchasers, inclusive of user costs, which is independent of these factors.
    사용자비용(user cost)에는 산업 집중도(자가 생산 자본재/중간재)와 상호거래(타가 생산 자본재/중간재의 상호거래) 문제가 끼어들기 때문에 사용자비용을 포함하는 총 구매금액을 이 문제를 배제하고 정의할 방도는 없다. 
  • [주3: 계속] There is a similar difficulty even in defining supply price in the ordinary sense for an individual producer; and in the case of the aggregate supply price of output as a whole serious difficulties of duplication are involved, which have not always been faced. If the term is to be interpreted gross of user cost, they can only be overcome by making special assumptions relating to the integration of entrepreneurs in groups according as they produce consumption-goods or capital-goods which are obscure and complicated in themselves and do not correspond to the facts. If, however, aggregate supply price is defined as above net of user cost, the difficulties do not arise. The reader is advised, however, to await the fuller discussion in Chapter 6 and its appendix.
[P2] It follows that in a given situation of technique, resources and factor cost per unit of employment, the amount of employment, both in each individual firm and industry and in the aggregate, depends on the amount of the proceeds which the entrepreneurs expect to receive from the corresponding output.[4] For entrepreneurs will endeavour to fix the amount of employment at the level which they expect to maximise the excess of the proceeds over the factor cost.

[P3] (1) Let Z be the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z=φ(N), which can be called the aggregate supply function.[5] (2) Similarly, let D be the proceeds which entrepreneurs expect to receive from the employment of N men, the relationship between D and N being written D(N), which can be called the aggregate demand function.
  • [5] In Chapter 20 a function closely related to the above will be called the employment function.
[P4] Now if for a given value of N the expected proceeds are greater than the aggregate supply price, i.e. if D is greater than Z, there will be an incentive to entrepreneurs to increase employment beyond N and, if necessary, to raise costs by competing with one another for the factor of production, up to the value of N for which Z has become equal to D. Thus the volume of employment is given by the point of intersection between the aggregate demand function and the aggregate supply function; for it is at this point that the entrepreneurs' expectation of profits will be maximised. The value of D at the point of the aggregate demand function, where it is intersected by the aggregate supply function, will be called the effective demand. Since this is the substance of the General Theory of Employment, which it will be our object to expound, the succeeding chapters will be largely occupied with examining the various factors upon which these two functions depend.

[P5] The classical doctrine, on the other hand, which used to be expressed categorically in the statement that ‘Supply creates its own Demand’ and continues to underlie all the orthodox economic theory, involves a special assumption as the the relationship between these two functions. For [:]
  • ‘Supply creates its own Demand’ must mean that (N) and Φ(N) are equal for all values of N, i.e. for all levels of output and employment; and that when there is an increase in Z(=Φ(N)) corresponding to an increase in N, D(=(N)) necessarily increases by the same amount as Z
  • The classical theory assumes, in other words, that the aggregate demand price (or proceeds) always accommodates itself to the aggregate supply price; so that, whatever the value of N may be, the proceeds D assume a value equal to the aggregate supply price Z which corresponds to N
  • That is to say, effective demand, instead of having  a unique equilibrium value, is an infinite range of values all equally admissible; and the amount of employment is indeterminate except in so far as the marginal disutility of labour sets an upper limit.
[P6] If this were true, competition between entrepreneurs would always lead to an expansion of employment up to the point at which the supply of output as a whole ceases to be elastic, i.e. where a further increase in the value of the effective demand will no longer be accompanied by any increase in output.[※ 총공급의 최대 한도까지 고용될 것이다.] Evidently this amounts to the same thing as full employment. In the previous chapter we have given a definition of full employment in terms of the behaviour of labour. An alternative, though equivalent, criterion is that at which we have now arrived, namely a situation in which aggregate employment is inelastic in response to an increase in the effective demand for its output. Thus Say's Law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment. If, however, this is not true law relating the aggregate demand and supply functions, there is a vitally important chapter of economic theory which remains to be written and without which all discussions concerning the volume of aggregate employment are futile.


II.

[P1] A brief summary of the theory of employment to be worked out in the course of the following chapters may, perhaps, help the reader at this stage, even though it may not be fully intelligible. The terms involved will be more carefully defined in due course. In this summary we shall assume that the money-wage and other factor costs are constant per unit of labour employed. But this simplification, with which we shall dispense later, is introduced solely to facilitate the exposition. The essential character of the argument is precisely the same whether or not money-wages, etc., are liable to change.

[P2] The outline of our theory can be expressed as follows. When employment increases, aggregate real income is increased. The psychology of the community is such that when aggregate real income is increased aggregate consumption is increased, but not by so much as income. Hence employers would make a loss if the whole of the increased employment were to be devoted to satisfying the increased demand for immediate consumption. Thus, to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level. For unless there is this amount of investment, the receipts of the entrepreneurs will be less that is required to induce them to offer the given amount of employment.
  • (1) It follows, therefore, that given what we shall call the community's propensity to consume, the equilibrium level of employment, i.e. the level at which there is no inducement to employers as a whole either to expand or contract employment, will depend on the amount of current investment. 
  • (2) The amount of current investment will depend, in turn, on what we shall call the inducement to invest; and the inducement to invest will be found to depend on the relation between the schedule of the marginal efficiency of capital and the complex of rates of interest on loans of various maturities and risks.
The outline of our theory can be expressed as follows. When employment increases, aggregate real income is increased. The psychology of the community is such that when aggregate real income is increased aggregate consumption is increased, but not by so much as income. Hence employers would make a loss if the whole of the increased employment were to be devoted to satisfying the increased demand for immediate consumption. Thus, to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level. For unless there is this amount of investment, the receipts of the entrepreneurs will be less that is required to induce them to offer the given amount of employment. It follows, therefore, that given what we shall call the community's propensity to consume, the equilibrium level of employment, i.e. the level at which there is no inducement to employers as a whole either to expand or contract employment, will depend on the amount of current investment. The amount of current investment will depend, in turn, on what we shall call the inducement to invest; and the inducement to invest will be found to depend on the relation between the schedule of the marginal efficiency of capital and the complex of rates of interest on loans of various maturities and risks.

[P3] Thus, given the propensity to consume and the rate of new investment, there will be only one level of employment consistent with equilibrium; since any other level will lead to inequality between the aggregate supply price of output as a while and its aggregate demand price. This level cannot be greater than full employment, i.e. the real wage cannot be less than the marginal disutility of labour. But there is no reason in general for expecting it to be equal to full employment. The effective demand associated with full employment is a special case, only realised when the propensity to consume and the inducement to invest stand in particular relationship to one another. This particular relationship, which corresponds to the assumptions of the classical theory, is in a sense an optimum relationship. But it can only exist when, by accident or design, current investment provides an amount of demand just equal to the excess of the aggregate supply price of the output resulting from full employment over what the community will choose to spend on consumption when it is fully employed.

[P4] This theory can be summed up in the following propositions:

(1) In a given situation of technique, resources and costs, income (both money-income and real income) depends on the volume of employment N.

(2) The relationship between the community's income and what it can be expected to spend on consumption, designated by D1, will depend on the psychological characteristic of the community, which we shall call its propensity to consume. That is to say, consumption will depend on the level of aggregate income and, therefore, on the level of employment N, except when there is some change in the propensity to consume.

(3) The amount of labour N which the entrepreneurs decide to employ depends on the sum(D) of two quantities, namely D1, the amount which the community is expected to spend on consumption, and D2, the amount which it is expected to devote to new investment. D is what we have called above the effective demand.

(4) Since D1+D2=D=Φ(N), where [? Φ(N)] is the aggregate supply function, and since, as we have seen in (2) above, D1 is a function of N, which we may write χ(N), depending on the propensity to consume, it follows that Φ(N)-χ(N)=D2.

(5) Hence the volume of employment in equilibrium depend on (ⅰ) the aggregate supply function, (ⅱ) the propensity to consume, and (ⅲ) the volume of investment, D2. This is the essence of the General Theory of Employment.

(6) [??] For every value of N there is a corresponding marginal productivity of labour in the wage-goods industries; and it is the which determines the real wage. (5) is, therefore, subject to the condition that N cannot exceed the value which reduces the real wage to equality with the marginal disutility of labour. This means that not all changes in D are compatible with our temporary assumption that money-wages are constant. Thus it will be essential to a full statement of our theory to dispense with this assumption.

(7) On the classical theory, according to which D=Φ(N) for all values of N, the volume of employment is in neutral equilibrium for all values of N less than its maximum value; so that the forces of competition between entrepreneurs may be expected to push it to this maximum value. Only at this point, on the classical theory, can there be stable equilibrium.

(8) When employment increases, D1 will increase, but not by so much as D; since when our income increases our consumption increases also, but not by so much. The key to our practical problem is to be found in this psychological law. For it follows from this that the greater the volume of employment the greater will be the gap between the aggregate supply price (Z) of the corresponding output and the sum (D1) which the entrepreneurs can expect to get back out of the expenditure of consumer. Hence, if there is no change in the propensity to consume, employment cannot increase, unless at the same time D2 is increasing so as to fill the increasing gap between Z and D1. Thusㅡexcept on the special assumptions of the classical theory according to which there is some force in operation which, when employment increases, always causes D2 to increase sufficiently to fill the widening gap between Z and D1ㅡthe economic system may find itself in stable equilibrium with N at a lower level below full employment, namely at the level given by the intersection of the aggregate demand function with the aggregate supply function.

[P5] Thus the volume of employment is not determined by the marginal disutility of labour measured in terms of real wages, except in so far as the supply of labour available at a given real wage sets a maximum level to employment. The propensity to consume and the rate of new investment determine between them the volume of employment, and the volume of employment is uniquely related to a given level of wagesㅡnot the other way round. If the propensity to consume and the rate of new investment result in a deficient effective demand, the actual level of employment will short of the supply of labour potentially available at the existing real wage, and the equilibrium real wage will be greater than the marginal disutility of the equilibrium level of employment.

[P6] This analysis supplies us with an explanation of the paradox of poverty in the midst of plenty. For the mere existence of an insufficiency of effective demand may, and often will, bring the increase of employment to a standstill before a level of full employment has been reached, The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment.

[P7] Moreover the richer the community, the wider will tend to be the gap between its actual and its potential production; and therefore the more obvious and outrageous the defect of the economic system. For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members. If in a potentially wealthy community the inducement to invest is weak, then, in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has become so poor that its surplus over is consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.

[P8] But worse still. Not only is the marginal propensity to consume[6] weaker in a wealthy community, but, owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest falls at a sufficiently rapid rate; which 'brings us to the theory of the rate of interest and to the reasons why it does not automatically fall to the appropriate level, which will occupy Book IV.

[P9] Thus the analysis of the propensity to consume, the definition of the marginal efficiency of capital and the theory of the rate of interest are the three main gaps in our existing knowledge which it will be necessary to fill. When this has been accomplished, we shall find that the theory of prices fall into its proper place as a matter which is subsidiary to our general theory. We shall discover, however, that money plays an essential part in our theory of the rate of interest; and we shall attempt to disentangle the peculiar characteristics of money which distinguish it from other things.


III

[P1] The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo's doctrine that it was impossible for effective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of effective demand with which Malthus had wrestled vanished from economic literature. You will not find even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has reached its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas.

[P2] The completeness of the Ricardian victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vat and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.

[P3] But although the doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purpose of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners. For professional economists, after Malthus, were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation;ㅡa discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord to economists that measure of respect which he gives to other groups of scientists whose theoretical results are confirmed by observation when they are applied to the facts.

[P4] The celebrated optimism of traditional economic theory, which has led to economists being looked upon a Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our economy to behave. But to assume that it actually does so is to assume our difficulties away.

주석...

[발췌] Trying to Make Sense of the Principle of Effective Demand

지은이: Jochen Hartwig (University of St. Gallen, Swiss Institute for Business Cycle Research, Zürich)
자료: http://www.cfeps.org/events/pk2002/confpapers/hartwig.pdf

* * *

abstract:

Most of the scholarly reinterpretations of the Principle of Effective Demand are not in line with Keynes's original presentation of it in Chapter 3 of the General Theory. To substantiate this claim, Keynes's definition is here first reproduced and then compared with different reinterpretations of the principle by textbook authors, and Neo-Ricardians, Kaleckian, and Post Keynesian economists. A new interpretation of the Principe of Effective Demand is suggested which links the Post Keynesian D/Z-model to a reproduction scheme thatㅡbroadly in the tradition of Marxㅡdistinguishes between the consumption- and investment-goods "departments".


1. The Principle of Effective Demand in the literature

1.1 Keynes's original presentation of the Principe of Effective Demand

In the first section of this paper it is argued that most of the scholarly interpretations of the Principle of Effective Demand are not in line with Keynes's own description thereof. Since this is a strong claim a full quote from the General Theory is called for:
“Let Z be the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z=Φ(N), which can be called the ^aggregate supply function^. Similarly, let D be the proceeds which entrepreneurs expect to receive from the employment of N men, the relationship between D and N being written D=f(N), which can be called the ^aggregate demand function^. Now if for a given value of N the expected proceeds are greater than the supply price, i.e. if D is greater than Z, there will be an incentive to entrepreneurs to increase employment beyond N and, if necessary, to raise costs by competing with one another for the factors of production, up to the value of N for which Z has become equal to D. Thus the volume of employment is given by the intersection between the aggregate demand function and the aggregate supply function; for it is at this point that entrepreneurs's expectation of profits will be maximised. The value of D at the point of the aggregate demand function where it intersected by the aggregate supply function, will be called ^the effective demand^”(KEYNES 1973A, p. 25).
In the next sentence Keynes declares Effective Demand "the substance of the General Theory of Employment". In view of his statement: "The object of our analysis is to discover that determines the volume of employment"(KEYNES 1973A, p.89), it is beyond doubt that the Principle of Effective Demand is the centerpiece of the economics of Keynes.[1]
[1] Keynes uses the expression "Principle of Effective Demand" in the title of Chapter 3 of the General Theory, but not in the given quotation and hardly ever again. A recent discussion has focussed the question whether the given quotation expresses a ^principle^(cf. Pasinetti 1996, Davidson 2001). Here, the ^Principle of Effective Demand^ is taken to state that the quantity of employment is fixed at the ^Point& of Effective Demand.
Keynes defines Effective Demand as a ^point^ of intersection of two curves.
  • Are those curves identical with the aggregate demand curve and the 45˚-line in the famous "Keynesian Cross"? They are not.
  • Even if we were prepared to ignore the facts that the two functions D and Z as defined by Keynes are specified in nominal terms while those of the Income-Expenditure-model are in real terms, and that Keynes's functions depend on expectations while Keynesian Cross-functions do not, it would still impossible to mix up Keynes's aggregate supply function Z with the 45˚-line. (1) Z depends on employment, the 45˚-line does not; (2) Z incorporates profit maximization (see below), the 45˚-line does not; (3) Z has a distinguishable price- and quantity-component (see below), 45˚-line does not.
  • In short, unlike Z, the 45˚-line is no autonomous supply function, it is a "helping line" (SAMUELSON 1948, p. 257)ㅡit is just there to find out which level of income is consistent with the aggregate demand it supports, given the assumptions made about the aggregate demand schedule.

1.2 The Principle of Effective Demand in textbook-economics

What do students of economics learn about Effective Demand from their textbooks? The answer of this question is important because "(s)tandard textbooks are deliberate attempts to represent the consensus concerning accepted facts(and theories) in a given area of study. ... Any would-be textbook whose contents deviates (sic!) from this will fail as a textbook since it will not be generally used" (BOLAND 1991, p. 14). We should be on the safe side in assuming that what has fought its way into those textbook is regarded as "conventional wisdon" by the discipline's mainstream.

Perhaps the most influential textbook ever written is Paul A. Samuelson's ECONOMICS. But although the macroeconomic framework of ECONOMICS evolves from a simple Income-Expenditure model(SAMUELSON 1948, Chapter 12) via the same model supplemented by an IS-LM-analysis (SAMUELSON 1973, Chapter 12 plus appendix to Chapter 18) into a combination of the Keynesian Cross with AS/AD-analysis(SAMUELSON/NORDHAUS 1995, Chapter 24), neither in the first nor in the later editions of the book is the term "Effective Demand" ever mentioned. And this holds for many other best-selling textbooks too.[2]
[2] Of course, I cannot provide a complete overview. I examined the following textbooksㅡwhich had been indicated to me by colleagues as most often assigned in undergraduate intermediate macro courses and/or used in first-year graduate courses since the 60sㅡwithout finding any reference to the Principe of Effective Demand: ACKLEY 1969, HALL/TAYLOR 1991, GORDON 1993, FROYEN 1996, BARRO 1997, DORNBUSCH/FISCHER/STARTZ 1998, and MANKIW 2000. I also checked earlier editions of these books (in most cases back to the first edition) to see if a reference to the Principle of Effective Demand might have disappeared in the course of time, but this is not the case. The same holds for advanced-level textbooks such as BLANCHARD/FISCHER 1989, and ROMER 1996.

Textbooks tend to neglect Effective Demand. But there is a revealing exception in a textbook most prominent in the German-speaking countries: FELDERER/HOMBURG 1999. The 32nd section of this book is called "Effective Demand". There the authors write: “The crux of the argumentation lies in the fact that Keynes points attention to effective demand, defined as aggregate demand backed by purchasing power in an economy”(FELDERER/HOMBURG 1999, p. 102, my translation). Felderer/Homburg treat Effective Demand as equivalent to aggregate demand. Their additional remark that effective demand is backed by purchasing power while aggregate demand could be just notional (cf. p. 102) seems odd: in all Anglo-Saxon textbooks mentioned above it is presupposed that aggregate demand is not just notional. So it is no surprise that on page 112f. of their book Ferderer/Homburg define Effective Demand as the sum of consumption- and investment-demand (what the others call aggregate demand), equate that with output and end up with the familiar Keynesian Cross.

To sum up, mainstream textbooks either neglect Effective Demand or confuse it with aggregate demand.[3] The implications of this practice are severe, since the substitution of aggregate demand for Effective Demand seems to be mainly responsible for some influential misinterpretations of Keynes's theory still defending their place in those textbooks:

  • the conclusion drawn from the income-expenditure(45˚-) model that Keynes simply shifted the equilibrium role (between supply and demand) from prices to quantitiesㅡthe notion of "fast quantities" but "slow prices" in Keynes's theory (originating Leijonhufvud[4]); or 
  • the notion that Keynes has simply turned Say's Law upside downㅡnot every supply creates its own demand but every demand creates its own supply(cf. FELDERER/HOMBURG 1999, p. 102f.). 
As will be argued below these ideas are not compatible with Keynes's Principle of Effective Demand.
[3] Another example for this confusion by a renowned economist would be: "The General Theory emphasised ^effective demand^ㅡwhat we now call ^aggregated demand^", BLANCHARD 2000, p. 538.
[4] “In the Keynesian macrosystem the Marshallian ranking of price- and quantity-adjustment speeds is reversed: in the shortest period flow quantities are freely variable, but one or more prices are given, and the admissible range of variation for the rest of the prices is thereby limited. The ‘revolutionary’ element of the General Theory can perhaps not be stated in simpler terms”(LEIJONHUFVUD 1968, p. 52). Leijonhufvud later stepped back from this interpretation(cf. LEIJONHUFVUD 1974), but it is still alive in the Neo-Keynesian school. 

1.3 The Principle of Effective Demand in Neo-Ricardian economics: (... ...)


1.4 The Principle of Effective Demand in Kaleckian economics

This section is concerned with the interpretation of the Principle of Effective Demand within a group of economist who are united by their conviction that it is important distinguish different sectors of an economy as well as different income groups (in other words: paying attention to distributive aspects). Some of them are sometimes referred to as Post-Keynesians. I prefer to call their approach Kaleckianㅡon the one hand because they themselves declare their indebtedness to Kalecki and on the other hand to distinguish them from the authors to be dealt with in the next section.

Chapter three of the second book of ROBINSON/EATWELL 1973 is called "Effective Demand". After having stated that they intend to follow Kalecki rather than Keynes the authors present a reproduction scheme with two departments (sectors), one of which produces wheat, the other machines. If a certain rate of profit and propensity to save (or different propensity to save for different income groups) are assumed, a specific proportion of the two departments in value terms (what BHADURI 1986, p. 40, calls "macroeconomic balance equation") can be calculated. If the two departments are in proportion (given by the "balance equation"), their whole output can be sold for its value (or price of production). Since profit is incorporated in the value [?of] product, "macroeconomic balance" is equivalent to maximization of of the ^realized^ profit or to realization of the maximum profit respectively. (Since all of this plays an important role in my own reinterpretation of the Principle of Effective Demand I relegate an in-depth discussion of these topics on the third section of this paper.) If, on the other hand, the two department are out of balance, demand does not equal supply. The authors of the Kaleckian school assume that in such a situation a quantity reaction of real income closes the gap. To recapitulate: There is only one proportion of departments in which demand equals supply, and this equilibrium proportion is brought about by quantity reactions. This is seen to be the Principle of Effective Demand (cf., eg., ROBINSON/EATWELL 1973, book 2, Chapter 3; BHADURI 1986, Chapter 2; NELL 1998, Chapter 11).

As will be argued in more detail below the "macroeconomic balance equation" is identical to Keynes's "logical" multiplier relation while the alleged quantity reaction which brings about the correct proportion of departments is his dynamic multiplier process (cf. KEYNES 1973A, p. 122f.). If we consider this, the Kaleckian interpretation of the Principle of Effective Demand bears a striking resemblance to the Neo-Ricardian and (if at all) the textbook-view of the Principle of Effective Demand: Its essence is claimed to be a quantity reaction of real income which brings about "equilibrium", and which could be labeled "multiplier process". None of these camps mention the two functions D and Z that Keynes uses to illustrate the Principle of Effective Demand.

1.5 The Principle of Effective Demand in Post Keynesian economics

In this paper, I reserve the term "Post Keynesian" for authors who follow Keynes in his presentation of the Principle of Effective Demand in terms of the two functions D and Z.

Probably the first scholar who ever drew D- and Z-curves was Sidney Weintraub. His diagram looks like this (cf. WEINTRAUB 1958, p. 39):[.] Weintraub called the point of intersection of these two curves "the income-employment equilibrium". It was Paul Davidson who got back to Keynes's coining "point of effective demand" (cf. DAVIDSON/SMOLENSKY 1964, p. 4-6; DAVIDSON 1978, pp. 22, 44-49) and who has been the perhaps most audible advocate of the D/Z-model ever since (cf. also DAVIDSON 1994, Chapter 2).

How do these two authors define the D- and Z-curves? DAVIDSON 1994, p. 19, writes about Z:
“Keynes's aggregate supply function represents the relationship between entrepreneurs' expected sales revenues tomorrow and the amount of today's labour hiring that the entrepreneurs require to produce sufficient output to meet tomorrow's expected demand.”
Herein he follows WEINTRAUB 1958, p. 25. If we compare this with the quotation given above in section 1.1 we recognize that Weintraub and Davidson call "Z" what Keynes called "D". What, then, do Davidson and Weintraub call "D"?
“The aggregate demand function (D) represents the desired expenditures of all buyers at any level of aggregate employment”, DAVIDSON (1994), p. 19, cf. WEINTRAUB 1958, p. 31.
Whereas for Keynes D represents "the proceeds which entrepreneurs expect to receive from the employment of N men", that is, a magnitude the suppliers are concerned about, for Weibtraub and Davidson D represents something which is contemplated by the other side of the marketㅡthe buyers. There interpretation of the Principle of Effective Demand cannot claim to be in line with Keynes's expositions in Chapter 3 of the General Theory.[6]
[6] (a long remark follows...)

Other (mostly Post Keynesian) authors follow Keynes's model more closely in that they recognize that D refers to aggregate demand as expected by the suppliers.[7] (Let me postpone a discussion of Z until the next section.) The question then arising is what shape the D-curve has. In Weintraub and Davidson's presentation the D-curve is strictly concave. But while it is uncontroversial that the aggregate demand curve ^as realized ex post^ must be strictly concave as long as the marginal propensity to consume is smaller that 1 (Keynes's "fundamental psychological law") and as long as there are decreasing returns to labor,[8], it is less clear why the same should hold for the D-curve in expectation terms. As PARINELLO 1980, p. 69-70, notes, the individual producer's expected demand curve is a horizontal line in a diagram with her own offers of employment as abscissa and her own expected proceeds as ordinate(cf. also WELLS 1987, p. 512). No single producer expects her own proceeds to be negatively influenced if she cuts back employment, but if all of them did so, aggregate proceeds would certainly be smaller. But how does this aggregate result come about? Certainly there should be some kind of connection between the individual behavior of the producers and the aggregate result. I offer an explanation in the next section in the context of my own reinterpretation of the Principle of Effective Demand.[9]

2. Proposal for a thoroughgoing interpretation of the Principle of Effective Demand


(... ...)

[발췌] Aggregate Supply and Demand: An Explanation of Chapter III of the General Theory


지은이: Paul Wells
출처: The Canadian Journal of Economics and Political Science, vol. 28, No. 4 (Nov. 1962), pp. 585-590

* * *

In Chapter III of The General Theory of Employment, Interest and Money Keynes provides the reader with two conceptually different and unrelated summaries of his short-run theory of employment. He expresses these two brief accounts in terms of three macroeconomic relations:
  • an aggregate demand function that is the sum of consumer and investment spending;
  • an aggregate supply function that states the proceeds entrepreneurs must obtain from the sale of output if a given level of employment is to be maintained; and
  • what we may call an "expected proceeds" function that relates the receipts entrepreneurs expect to receive from the sale of output to the volume of employment necessary to produce the output. 

Because Keynes does not show explicitly the connection between his two summaries, and because he employs two relations that today seem still to puzzle many economists, students of the General Theory are likely to find this important chapter difficult, if not impossible, to understand. This is highly unfortunate, for we aim to show that this chapter constitutes a very eloquent and valuable epitome of Keynes's short-run theory of employment.

I. Keynes's First Summary

The first of Keynes's brief accounts runs as follows:
It follows that in a given situation of technique, resources and factor cost per unit of employment, the amount of employment, both in each individual and industry and in the aggregate, depends on the amount of proceeds which the entrepreneurs expect to receive from the corresponding output. For entrepreneurs will endeavour to fix the amount of employment at the level which they expect to maximise the excess of the proceeds over the factor cost.
  Let Z be the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z=Φ(N), which can be called the ^Aggregate Supply Function^. Similarly, let D be the proceeds which entrepreneurs expect to receive from te employment of N men, the relationship between D and N being written D=f(N) , which can be called the ^Aggregate Demand Function^.
  Now if for a given value of N the expected proceeds are greater than the aggregate supply price, i.e. if D is greater than Z, there will be an incentive to entrepreneurs to increase employment beyond N and, if necessary, to raise costs by competing with one another for the factors of production, up to the value of N for which Z has become equal to D. Thus the volume of employment is given by the point of intersection between the aggregate demand function and the aggregate supply function; for it is at this point that the entrepreneurs' expectation of profits will be maximised.[1]

To understand this passage we need to attach definite meanings to Keynes's aggregate supply function, Z=Φ(N), and to D=f(N), which Keynes calls, unluckily, an "aggregate demand" function, but which we shall call an "expected proceeds" function so as not to confuse this relation with the sum of consumer and investment spending.

1. ^The aggregate supply function^ is a relation between employment, N, and a sum of money receipts, Z, that states the aggregate revenues entrepreneurs must receive from the sale of output if they are to maintain a given level of employment. This function ^does not^ state the actual receipts entrepreneurs do receive from the sale of output that results from a given level of employment; it simply expresses, for each volume of employment, the minimal receipts which must be forthcoming to support various levels of employment.

To establish the exact relation between employment and the necessary receipts entrepreneurs must obtain we need to assume that: (a) the problem of aggregation has been solved, (b) perfect competition exists, (c) a given money wage rate w obtains, (d) varying amounts of X, final output measured in real terms, are produced with a fixed amount of capital equipment together with varying amounts of labour. Thus the short run aggregate production function may be written as X=X(N). In addition we shall make the customary assumptions[2] concerning the shape of this function, namely, that X'>0, X''<0, and X'''=0.

Under conditions of perfect competition firms adjust their rates of output until marginal cost, w/X', equals the per-unit price of output, P. Thus we have the following microeconomic equilibrium condition holding for all firms in the economy.

(1.1) P = w/X'

Multiplying both sides of this equation by X, total physical output of the final good produced by all firms in the economy, gives us the corresponding macroeconomic equilibrium condition.

(1.2) PX = (w/X')X

Since the product PX is simply the sum total of all expenditures on final output, and is, in equilibrium, equal to Z, the sume of money receipts necessary to support the amount of employment necessary to produce an output X, we may rewrite equation (1.2) as

(1.3) Z = (w/X') X

This equation states the necessary sum of money, Z, entrepreneurs must receive if they are to maintain a rate of output X. The relation we seek to define, however is between the variable Z and N, not between Z and X. To find this relation we replace X in equation (1.3) by Xbar N, where Xbar denotes the average productivity of labour. Thus Xbar N is simply the total output produced by a given amount of labour N. This substitution yields the exact form of Keynes's elusive aggregate supply function.

(1.4) Z = (w Xbar)/X' N

This equation states the minimal proceeds, Z, entrepreneurs must earn from the sale of output if the established level of employment, N, is to be maintained. If the actual receipts accruing to entrepreneurs exceeds (falls short of) Z, then employment will rise (fall) until equation (1.4) satisfied. 

Because Xbar/X', the elasticity of output with respect to employment, ^decreases^ as employment increases,[3] this relation is drawn, Figure 1, convex to the abscissa. This means that in order for higher levels of employment to be established proportionately larger increments in expenditure and receipts are necessary. An additional property of this function is that it is not defined for points beyond Nf (Figure 1), the size of the labour force

2. ^The expected proceeds function^ states that the proceeds, D, entrepreneurs expect to realize from the sale of output resulting from the employment of a certain amount of labour. These proceed are simple the product of the price expected by entrepreneurs, P~, and the physical output they produce, X. If we assume that the expected price is a diminishing function of output, then both P~ and X, and their product D, are functions of the level of employment. This function is concave to the absissa (Figure 1) because of diminishing marginal returns in production and because of the assumed inverse relation between the expected price and employment. Thus, in the minds of entrepreneurs, given increments in employment produce constantly decreasing additions to expected proceeds.

From the definitions we have give these two relations, and from the implicit assumptions of Keynes that expected proceeds will equal realized revenues, it follows that ^expected^ profits will be maximized if sufficient labour is employed to equate expected proceeds, D, to the aggregate supply of output, Z. For if D = Z, the P~X = (w/X')X, and the expected price will equal the marginal cost of production. Thus the intersection of these two curves at point a(Figure 1) illustrates the expected equilibrium level of employment, Ne, according to the first of Keynes's two summaries. As can be seen from the diagram this equilibrium is stable barring changes in any of the parameters of the system. At a higher(lower) level of employment, marginal cost would exceed (fall short of) the expected price and entrepreneurs would make the appropriate adjustment in their rates of output.

Strangely enough, in this account of his theory of employment Keynes makes no direct use of one of his major contributions to economic theory, The Principle of Effective Demand, for in this summary the unknowns are simply employment, output, and expected proceeds. The relations necessary to determine their equilibrium values are the aggregate supply function, the production function, and the price expectations of entrepreneurs.


II. The Second Summary

Keynes expresses his second summary in the forms of five separate points. They are:
(... ...)
(... ...)

From the above two summaries we may conclude that Chapter III of the General Theory teaches us, contrary to many of the popularized accounts of this book, that ^expectations^ and ^supply^, as well as demand, play important roles in Keynes's short run theory of employment. Though one may agree with Patinkin's oft-repeated charge that Keynesian economics "overlooks the supply side of the commodity market"[6] it is clear that the General Theory does not.[7]

[7] Additional support for this conclusion is to be found in chapters 20 and 21 of the General Theory, and in H. Neisser, "Keynes's Aggregate Supply Function: Further Comments," Economic Journal, LXXI, 850-2.

Temporary keeping of links



http://www.jstor.org/stable/139298

http://www.cfeps.org/events/pk2002/confpapers/hartwig.pdf

http://www.jstor.org/stable/4537572

http://hal.archives-ouvertes.fr/docs/00/60/69/76/PDF/OA_on_effective_demand_papers_final_.pdf

http://www.umass.edu/economics/publications/2005-11.pdf

http://people.ds.cam.ac.uk/mgh37/The%20point%20of%20effective%20demand.pdf

http://mpra.ub.uni-muenchen.de/12837/1/Slip_of_the_Pen_WP_.pdf

그 중:


KEYNES' THEORY OF EFFECTIVE DEMAND REVISITED(ASIMAKOPULOS - 2008)
http://ideas.repec.org/a/bla/ausecp/v21y1982i38p18-36.html

The Price Level Implicit in Keynes's Effective Demand (Sergio Parrinello)
Journal of Post Keynesian Economics, Vol. 3, No. 1 (Autumn, 1980), pp. 63-78Published by: M.E. Sharpe, Inc.
http://www.jstor.org/stable/pdfplus/4537572.pdf?acceptTC=true

Point of Effective Demand
http://people.ds.cam.ac.uk/mgh37/The%20point%20of%20effective%20demand.pdf

[Short easy or lay guides on Chapter 3 of the GT] Effective Demand, AD, AS

자료 1: Tutors on Net


※ 발췌(excerpts):
※ some adjustments of  bad English expositions and errors are tried.

Principle of Effective Demand: Aggregate Demand and Aggregate Supply

■ Introduction: The logical starting point of Keynes's theory of employment is the principle of effective demand. In a[n] entrepreneurial economy, the level of employment is based on effective demand. Thus employment[? unemployment] results from a deficiency of effective demand[,] and the level of employment can be raised by increasing the level of effective demand.

Aggregate Demand Price: “The aggregate demand price for the output of any given amount of employment is the total sum of money or proceeds which is expected from the sale of the output produced when that amount of labour is employed.” Thus the aggregate demand price is the amount of money which the entrepreneurs expect to get by selling the output produced by the number of men employed. In other words it refers to the expected revenue from the sale of output at a particular level of employment. Different aggregate demand prices relate to different levels of employment in the economy.

A statement showing the various aggregate demand prices at different levels of employment is called the aggregate demand price schedule or aggregate demand function[:] “The aggregate demand function[,]” according to Keynes, “relates any given level of employment to the expected proceeds from that level of employment.” The below tablet represents the aggregate demand schedule where it reveals that, with the increase in the level of employment[, expected proceeds] rise, and at lower levels of employment [they] decline. When 900 thousands people are provided employment[,] the aggregate demand price is $560 million , and when 250 thousand people are provided jobs it is $480 million. According to Keynes the aggregate demand function is an increasing function of the level of employment and is expressed as D=F(N), where D is the proceeds which entrepreneurs expect from the employment of N men.

Level of Employment in 1000 thousands  ;  Aggregate Demand Price (D) in Million $
4 ; 460
5 ; 480
6 ; 500
7 ; 520
8 ; 540
9 ; 560
10 ; 580

The aggregate demand curve can be drawn on the basis of the above schedule. It inclines upwards from the left to the right for the reason that[, when] the level of employment increases aggregate demand price also rises, shown as AD curve in the upcoming diagram 1.

■ Aggregate Supply Price: When an entrepreneur gives employment to a definite amount of labour, it requires certain quantities of co-operant factors like land, capital, raw materials etc. which will be paid remuneration along with the labour. Thus each level of employment involves certain money costs of production including normal profits which the entrepreneur must cover. “At any given level of employment of labour aggregate supply price is the total amount of money which all the entrepreneurs in the economy, taken together[,] must expect to receive from the sale of the output produced by that given number of men, if it is to be just worth employing them.”

In brief, the aggregate supply price refers to the proceeds necessary from the sale of output at a particular level of employment. Thus each level of employment in the economy is related to a particular aggregate supply price and these [aggregate supply prices are different] for different levels of employment. A statement showing the various aggregate supply prices at different levels of employment is called aggregate price schedule or aggregate supply function[, i]n the words of Prof. Dillard[:] “The aggregate supply function is a schedule of the minimum amounts of proceeds required to induce varying quantities of employment.” The below tablet reveals the aggregate supply schedule,

Level of Employment (N) in 100 Thousands  ;  Aggregate Supply Price (Z) in Million $
4 ; 430
5 ; 460
6 ; 490
7 ; 520
8 ; 550
9 ; 580 [? 550]
10 ; 610 [? 550]

The above table reveals that the aggregate supply price rise with the [r]ise in the level of employment. If entrepreneurs are to provide employment to 400 thousand worker, they must receive $430 million from the sale of output produced by them. (...) But when the economy reaches the level of full employment(at 800 thousand workers[),] the aggregate supply price($550, $580, %610) continues to increase but there is no further [employment.] [Aggregate supply function] is an increasing function of the level of employment and is expressed z=Φ(N), Z [being] the aggregate supply price of the output level from employing N men. (... ...)


자료 2: WikiEducator

Keynes's theory of aggregate demand

(... ...) In the following sections we discuss Keynes' concept of aggregate demand function, aggregate supply function and finally, the point of effective demand.

Aggregate Demand Function

Aggregate demand or what is called aggregate demand price is the amount of total receipts which all the firms expect to receive from the sales of output produced by a given number of workers employed. Aggregate demand increases with increase in the number of workers employed. The aggregate demand function curve is a rising curve as shown in Fig. 1.

It can be seen that total expected receipts is D1L1 at 0L1 level of employment. Total expected receipts increase to D2L2 with increase in the level of employment to 0L2. 0Lf is the full employment level. Initially the aggregate demand function(ADF) rises sharply as increase in the number of employment leads to increase in society's expenditure, thereby, increasing producer's expected sales receipts. There is no much increase in employment, income, expenditure and therefore producer's expected sales receipts as the economy reaches near full employment. The ADF curve becomes perfectly elastic (horizontal) as the economy reaches near full-employment.

Aggregate Demand in Keynes's theory of income determination is society's planned expenditure. In a laissez-faire economy it consists of consumption of expenditure(C) and investment expenditure(I). Thus AD = planned expenditure = C + I (... ...)

Aggregate Supply Function

Aggregate supply is determined by physical ad technical conditions of production. However, these conditions remain constant in the short run. As such, given the technical conditions, output in the short run can be increased only by increasing employment of labour.

Aggregate supply or what is called aggregate supply price is the amount of total receipts which all the firms must expect to receive from the sale of output by a given number of workers employed. In other words, aggregate supply price is the total cost of production incurred by producers by employing a certain given number of workers. Obviously, aggregate supply price increases with increase in the number of workers employed. The aggregate supply function curve is a rising curve and at full employment(0Lf) it becomes perfectly inelastic (vertical) as shown in Fig. 2.

It can be seen that aggregate supply price or the cost of production is S1L1 at 0L1 level of employment. It increase to S2L2 with increase in the level of employment 0L2. Initially, the aggregate supply function (ASF) rises slowly as labour is abundant thereby leading to slow increase in the cost of production. Labour cost rises sharply a the economy reaches near full-employment. The ASF therefore rises [increasingly] sharply and at full employment(0Lf) it become perfectly inelastic (vertical).

Determination of Equilibrium Level of Employment

According to Keynes equilibrium level of employment (income) in the short run is determined by the level of effective demand. The higher the level of effective demand, the greater would be the level of income and employment and vice versa. This is shown in Fig. 3.

Fig. 3 shows the ADF and ASF together. As discussed above the ADF shows the amount of total receipts which all the firms expect to receive from the sale of output produced by a given number of workers employed and the ASF shows the amount of total receipts which all the firms must expect to receive from the sale of output produced by a given number of workers employed. Entrepreneurs expand output as long as there are opportunities to make profits.

It can be seen that up to 0L level of employment, aggregate demand price is greater than aggregate supply price (ADF>ASF). Producers expect greater returns than the cost of production. As such, producer expand output up to 0L level of employment. Thus at any level of employment up to 0L, there would be expansionary tendency in the economy and therefore rise in the level of employment.

Beyond 0L level of employment, aggregate demand price is less than aggregate supply price (ADF<ASF). Producers expect less returns than the cost of production. As such, producers prefer to cut down output. Thus at any level of employment beyond 0L, there would be contractionary tendency in the economy and therefore fall in the level of employment.

At 0L level of employment aggregate demand price equals aggregate supply price (ADF=ASF). Now there is no tendency towards economic expansion or contraction. Thus 0L is the equilibrium level of employment. Point 'E' is called point of effective demand. It represents that level of aggregate demand price that is equal to aggregate supply price and thus reaches short run equilibrium position.

It can be seen that equilibrium point 'E' is established at less-than-full employment equilibrium and there is LLf amount of involuntary unemployment in the economy. It is important to note that according to Keynes this unemployment is due to deficiency of aggregate demand. At full employment level there exist a gap between the full-employment level of aggregate supply price and the corresponding level of aggregate demand price. (... ...)

2013년 1월 28일 월요일

[발췌: 일반이론 2장] The Postulates of the Classical Economics

출처: The General Theory of Employment, Interest and Money (Keynes, 1936)
자료: MIA(html); eBook; single PDF; Gutenberg.au (cf. my catalog of his writings)


※ This is a reading note with excerpts taken and with personal annotations and remarks added in trying to understand the above text, so visit the source links to see the original.

※ 발췌(excerpts): 

Chapter 2_ The Postulates of the Classical Economics


Most treatises on the theory of value and production are primarily concerned with the distribution of a given volume of employed resources between different uses and with conditions which, assuming the employment of this quantity of resources, determine their relative rewards and the relative values of their products.[주1]

The question, also, of the volume of the available resources, in the sense of the size of the employable population, the extent of natural wealth and the accumulated capital equipment, has often been treated descriptively. But the pure theory of what determines the actual employment of the available resources has seldom been examined in great detail. To say that it has not been examined at all would, of course, be absurd. For every discussion concerning fluctuations of employment, of which there have been many, has been concerned with it. I mean, not that the topic has been overlooked, but that the fundamental theory underlying it has been deemed so simple and obvious that it has received, at the most, a bare mention.[주2]

The classical theory of employmentㅡsupposedly simple and obviousㅡhas been based, I think, on two fundamental postulates, though practically without discussion, namely:

I. The wage is equal to the marginal product of labour

That is to say, the wage of an employed person is equal to the value which would be lost if employment were to be reduced by one unit (after deducting any other costs which this reduction of output would avoid); subject, however, to the qualification that the equality may be disturbed, in accordance with certain principles, if competition and markets are imperfect.

II. The utility of the wage when a given volume of labour is equal to the marginal disutility of that amount of employment

That is to say, the real wage of an employed person is that which is just sufficient (in the estimation of the employed persons themselves) to induce the volume of labour actually emplloyed to be forthcoming; subject to the qualification that the equality for each individual unit of labour may be disturbed by combination between employable units analogous to the imperfections of competition which qualify the first postulate. Disutility must be here understood to cover every kind of reason which might lead a man or a body of men, to withhold their labour rather than accept a wage which had to them a utility below a certain minimum.
  • This postulate is compatible with what may be called 'frictional' unemployment. For a realistic interpretation of it legitimately allows for various inexactnesses of adjustment which stands in the way of continuous full employment: for example, unemployment due to a temporary want of balance between the relative quantities of specialised resources as a result of miscalculation or intermittent demand; or to (... ...) ; or to (... ...), so that there will always exist in a non-static society a proportion of resources unemployed 'between jobs'.
  • In addition to 'frictional' unemployment, the postulate is also compatible with 'voluntary' unemployment due to the refusal or inability of a unit of labour, as a result of legislation or social practices or of combination for collective bargaining or of slow response to change or of mere human obstinacy, to accept a reward corresponding to the value of the product attributable to its marginal productivity. 
But these two categories of ‘frictional’ unemployment and ‘voluntary’ unemployment are comprehensive. The classical postulates do not admit of the possibility of the third category, which I shall define below as ‘involuntary’ unemployment.

Subject to these qualifications, the volume of employed resources is duly determined, according to the classical theory, by the two postulates. The first gives us the demand schedule for employment, the second gives us the supply schedule; and the amount of employment fixed at the point where the utility of the marginal product balances the disutility of the marginal employment. It would follow from this that there are only four possible means of increasing employment:
  • (a) An improvement in organisation or in foresight which diminishes ‘frictional’ unemployment;
  • (b) a decrease in the marginal disutility of labour, as expressed by the real wage for which additional labour is available, so as to diminish ‘voluntary’ unemployment;
  • (c) an increase in the marginal physical productivity of labour in the wage-goods industries (to use Professor Pigou's convenient term for goods upon the price of which the utility of the money-wage depends);
  • or (d) an increase in the price of non-wage-goods compared with the price of wage-goods, associated with a shift in the expenditure of non-wage-earners from wage-goods to non-wage-goods.
This, to the best of my understanding, is the substance of Professor Pigou's Theory of Unemploymentㅡthe only detailed account of the classical theory of employment which exists.[주3]


II

Is it true that the above categories are comprehensive in view of the fact that the population generally is seldom doing as much work as it would like to do on the basis of the current wage? For, admittedly, more labour would, as a rule, be forthcoming at the existing money-wage if it were demanded.[주4] The classical school reconcile this phenomenon with their second postulate by arguing [:]
  • that, while the demand for labour at the existing money-wage may be satisfied before everyone willing to work at this wage is employed, this situation is due to an open or tacit agreement amongst workers not to work for less, and 
  • that if labour as a whole would agree to a reduction of money-wages more employment would be forthcoming. 
If this is the case, such unemployment, though apparently involuntary, is not strictly so, and ought to be included under the above category of ‘voluntary’ unemployment due to the effects of collective bargaining, etc.

This calls for two observations, the first of which relates to (1) the actual attitude of worker towards real wages and money-wages respectively and is not theoretically fundamental, but (2) the second of which is fundamental.

(1)
Let us assume, for the moment, that labour is not prepared to work for a lower money-wage and that a reduction in the existing level of money-wages would lead, through strikes or otherwise, to a withdrawal from the labour market of labour which is now employed. Does it follow from this that the existing level of real wages accurately measure the marginal disutility of labour? Not necessarily. For, [:]
  • although a reduction in the existing money-wage would lead to a withdrawal of labour, it does not follow that a fall in the value of the existing money-wage in terms of wage-goods would do so, if it were due to a rise in the price of the latter. 
  • In other word it may be the case that within a certain range the demand of labour is for a minimum money-wage and not for a minimum real wage. 
The classical school have tacitly assumed that this would involve no significant change in their theory. But this is not so. For if the supply of labour is not a function of real wages as its sole variable, their argument breaks down entirely and leaves the question of what the actual employment will be quite indeterminate.[주5: see App to #19] They do not seem to have realised that, unless the supply of labour is a function of real wages alone, their supply curve for labour will shift bodily with every movement of prices. Thus their method is tied up with their very special assumptions, and cannot be adapted to deal with the more general case.

Now ordinary experience tells us, beyond doubt, that a situation where labour stipulates (within limit) for a money-wage rather than a real wage, so far from being a mere possibility, is the normal case. Whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labour whenever there is a rise in the price of wage-goods. It is sometimes said that it would be illogical for labour to resist a reduction of money-wages but not to resist a reduction of real wages. For reasons given below(p. 14), this might not be so illogical as it appears at first; and, as we shall see later, fortunately so. But whether logical or illogical, experience shows that this is how labor in fact behaves.

Moreover, the contention that the unemployment which characterises a depression is due to a refusal by labour to accept a reduction on money-wages is not clearly supported by the facts. It is not very plausible to assert that unemployment in the United States in 1932 was due either to labour obstinately refusing to accept a reduction of money-wages or to its obstinately demanding a real wage beyond what the productivity of the economic machine was capable of furnishing. Wide variations are experienced in the volume of employment without any apparent change either in the minimum real demands of labour or in its productivity. Labour is nor more truculent in the depression than in the boomㅡfar from it. Nor is its physical productivity less. These facts from experience are a prima facie ground for questioning the adequacy of the classical analysis.

It would be interesting to see the results of a statistical enquiry into the actual relationship between changes in money-wages and changes in real wages. In the case of a change peculiar to a particular industry one would expect the change in real wages to be in the same direction as the change in money-wage. But in the case of changes in the general level of wages, it will be found, I think, that the change in real wages associated with a change in money-wages, so far from being usually in the same direction, is almost always in the opposite direction. When money-wages are rising, that is to say, it will be found that real wages are falling; and when money-wages are falling, real wages are rising. This is because, in the short period, falling money-wages and rising real wages are each, for independent reasons, likely to accompany decreasing employment; labour being readier to accept wage-cuts when employment is falling off, yet real wages inevitably rising in the same circumstances on account of the increasing marginal return to a given capital equipment when output is diminished.

If, indeed, it were true that the existing real wage is a minimum below which more labour than is now employed will not be forthcoming in any circumstances, involuntary unemployment, apart from frictional unemployment, would be non-existant. But to suppose that this is invariably the case would be absurd. For more labour than is at present employed is usually available at the existing money-wage, even though the price of wage-goods is rising and, consequently, the real wage falling. If this is true, the wage-goods equivalent of the existing money-wage is not an accurate indication of the marginal disutility of labour, and the second postulate does not hold good.

(2)
But there is a more fundament objection. The second postulate flows from the idea that the real wages of labour depends on the wage bargains which labour makes with the entrepreneurs. It is admitted, of course, that the bargains are actually made in terms of money, and even that the real wages acceptable to labour are not altogether independent of what the corresponding money-wage happens to be.
  • Nevertheless it is the money-wage thus arrived at which is held to determine the real wage. Thus the classical theory assumes that it is always open to labour to reduce its real wage by accepting a reduction in its money wage
  • The postulate that there is a tendency for the real wage to come to equality with the marginal disutility of labour clearly presumes that labour itself is in a position to decide the real wage for which it works, though not the quantity of employment forthcoming at this wage.
The traditional theory maintains, in short, that the wage bargains between the entrepreneurs and the workers determine the real wage; so that, assuming free competition amongst employers and no restrictive combination amonst workers, the latter can, if they wish, bring their real wages into conformity with the marginal disutility of the amount of employment offered by the employers at that wage. If this is not true, then there is no longer any reason to expect a tendency towards equality between the real wage and the marginal disutility of labour.

The classical conclusions are intended, it must be remembered, to apply to the whole body of labour and do not mean merely that a single individual can get employment by accepting a cut in money-wages which his fellows refuse. They are supposed to be equally applicable to a closed system as to an open system, and are not dependent on the characteristics of an open system or on the effects of a reduction of money-wages in a single country on its foreign trade, which lie, of course, entirely outside the field of this discussion. Nor are they based on indirect effects due to a lower wage-bill in terms of money having certain reactions on the banking system and the state of credit, effects which we shall examine in detail in chapter 19. They are based on the belief that in a closed system a reduction in the general level of money-wages will be accompanied, at any rate in the short period and subject only to minor qualifications, by some, though not always a proportionate, reduction in real wages.

Now the assumption that the general level of real wages depends on the money-wage bargains between the employers and the workers is not obviously true. Indeed it is strange that so little attempt should have been made to prove or to refute it. For it is far from being consistent with the general tenor of the classical theory, which has taught us to believe that prices are governed by marginal prime cost in terms of money and that money-wages largely govern marginal prime cost.
  • Thus if money-wages change, one would have expected the classical school to argue that prices would change in almost the same proportion, leaving the real wage and the level of unemployment practically the same as before, any small gain or loss to labour being at the expense or profit of other elements of marginal cost which have been left unaltered.[주6] 
  • They seem, however, to have been diverted from this line of thought, partly by the settled conviction that labour is in a position to determine its own real wage and partly, perhaps, by preoccupation with the idea that prices depends on the quantity of money. 
  • And the belief in the proposition that labour is always in a position to determine its own real wage, once adopted, has been unattained by its being confused with the proposition that labour is always in a position to determine what real wage shall correspond to full employment, i.e. the maximum quantity of employment which is compatible with a given real wage.
To sum up: there are two objections to the second postulate of the classical theory.
  • (1) The first relates to the actual behaviour of labour. A fall in real wages due to a rise in prices, with money-wages unaltered, does not, as a rule, cause the supply of available labour on offer at the current wage to fall below the amount actually employed prior to the rise of prices. To state it does is to suppose that all those who are now unemployed though willing to work at the current wage will withdraw the offer of their labour in the event of even a small rise in the cost of living. Yet this strange supposition apparently underlies Professor Pigou's Theory of Unemployment,[주7] and it is what all members of the orthodox school are tacitly assuming.
(2)
But the other, more fundamental, objection, which we shall develop in the ensuing chapters, flows from our disputing the assumption that the general level of real wages is directly determined by the character of the wage bargain. In assuming that the wage bargain determines the real wage the classical school have slept in an illicit assumption. For [:]
  • there may be no method available to labour as a whole whereby it can bring the wage-goods equivalent of the general level of money wages into conformity with the marginal disutility of the current volume of employment. 
  • There may exist no expedient by which labour as a whole can reduce its real wage to a given figure by making revised money bargains with the entrepreneurs. This will be our contention. 
We shall endeavour to show that primarily it is certain other forces which determine the general level of real wages. The attempt to elucidate this problem will be one of our main themes. We shall argue that there has been a fundamental misunderstanding of how in this respect the economy in which we live actually works.


III

Though the struggle over money-wage between individuals and groups is often believed to determine the general level o real-wages, it is, in fact, concerned with a different object. Since there is imperfect mobility of lbaout, and wages do not tend to an exact equality of net advantage in different occupations, any individual or group of individuals, who consent to a reduction of money wages relatively to others, will suffer a relative reduction in real wages, which is a sufficient justification for them to resist it. On the other hand it would be impracticable to resist every reduction of real wages, due to a change in the purchasing-power of money which affects all worker alike; and in fact reduction of real wages arising in this way are not, as a rule, reisted unless they proceed to an extreme degree. Moreover, resistance to reductions in money-wages applying to particular industries does not raise the same insuperable bar to an increse in aggregate employment which would result from a similar resistance to every reduction in real wages.

In other words, the struggle about money-wages primarily affects the distribution of the aggregate real wage between different labour-groups, and not its average amount per unit of employment, which depends, as we shall see, on a defferent set of forces. The effects of combinatin on the part of a group of workers is to protect their relative real wage. The general level of real wages depends on the other forces of the economic system.

Thus it is fortunate that the workers, though unconsciously, are instinctively more reasonable economists than the classical school, inasmuch as they resist reductions of money-wages, which are seldom or never of an all-round character, even though the existing real equivalent of these wages exceeds the marginal disutility of the existing employment; whereas they do not resist reductions of real wages, which are associated with increases in aggregate employment and leave relative money-wage unchanged, unless the reduction proceeds so far as to threaten a reduction of the real wage below the marginal disutility of the existing volume of employment. Every trade union will put up some resistance to a cut in money-wages, however small. But since no trade union would dream of striking on every occasion of a rise in the cost of living, they do not raise the obstacle to any increase in aggregate employment which is attributed to them by the classical school.


IV

We must now define the third category of unemployment, namely ‘involuntary’ unemployment in the strict sense, the possibility of which the classical theory does not admit.

Clearly we do not mean by ‘involuntary’ unemployment the mere existence of an unexhausted capacity to work. An eight-hour day does not constitute unemployment because it is not beyond human capacity to work ten hours. Nor should we regard as ‘involuntary’ unemployment the withdrawal of their labour by a body of workers because they do not choose to work for less that a certain real reward. Furthermore, it will be convenient to exclude ‘frictional’ unemployment from our definition of ‘involuntary’ unemployment. My definition is, therefore, as follows: Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. An alternative definition, which amounts, however, to the same thing will be given in the next chapter (Chapter 3).

It follows from this definition that the equality of the real wage to the marginal disutility of employment presupposed by the second postulate, realistically interpreted, corresponds to the absence of 'involuntary' unemployment. This state of affairs we shall describe as 'full' employment, both 'frictional' and 'voluntary' unemployment being consistent with 'full' employment thus defined. This fits in, we shall find, with other characteristics of the classical theory, which is best regarded as a theory of distribution in conditions of full employment. So long as the classical postulates hold good, unemployment, which is in the above sense involuntary, cannot occur. (... ...) Thus writers in the classical tradition, overlooking the special assumption underlying their theory, have been driven inevitably to the conclusion, perfectly logical on their assumption, that apparent unemployment (apart from the admitted exceptions) must be due to at bottom to a refusal by the unemployed factors to accept a reward which corresponds to their marginal productivity. A classical economist may sympathise with labour in refusing to accept a cut in its money-wage, and he will admit that it may not be wise to make it[cut in money-wage] to meet conditions which are temporary; but scientific integrity forces him to declare that this refusal [‘this refusal’, not ‘his refusal’] is, nevertheless, at the bottom of the trouble.

Obviously, however, if the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemploymentㅡif there be such a thing(and who will deny it?). The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straightㅡas the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible.


V

In emphasising our point of departure from the classical system, we must not overlook an important point of agreement. For we shall maintain the first postulate as heretofore, subject only to the same qualifications as in the classical theory; and we must pause, for a moment, to consider what this involves.

It means that, with a given organisation, equipment and technique, real wages and the volume of output (and hence of employment) are uniquely correlated, so that, in general, an increase in employment can only occur to the accompaniment of a decline in the rate of real wages. Thus I am not disputing this vital fact which the classical economists have (rightly) asserted as indefeasible. In a given state of organisation, equipment and technique, the real wage earned by a unit of labour has a unique (inverse) correlation with the volume of employment. Thus if employment increases, then, in the short period, the reward per unit of labour in terms of wage-goods must, in general, decline and profits increase.[주8] This is simply the obverse of the familiar proposition that industry is normally working subject to decreasing returns in the short period during which equipment etc. is assumed to be constant; so that the marginal product in the wage-good industries (which governs real wages) necessarily diminishes as employment is increased. So long, indeed, as this proposition holds, any means of increasing employment must lead at the same time to a diminution of the marginal product and hence of the rate of wages measured in terms of this product.
[주]8. The argument runs as follows: n men are employed, the nth man add a bushel a day to the harvest, and wages have a buying power of a bushel a day. The (n+1)th man, however, would only add 0.9 bushel a day, and employment cannot, therefore rise to (n+1) men unless the price of corn rises relatively to wages until daily wages have a buying power of 0.9 bushel. Aggregate wages would then amount to 9/10 (n+1) bushels as compared with n bushels previously. Thus the employment of an additional man will, if it occurs, necessarily involve a transfer of income from those previously in work to the entrepreneurs.
But when we have thrown over the second postulate, a decline in employment, although necessarily associated with labour's receiving a wage equal in value to a larger quantity of wage-goods, is not necessarily due to labour's demanding a larger quantity of wage-goods; and a willingness on the part of labour to accept lower money-wages is not necessarily a remedy for unemployment. The theory of wages in relation to employment, to which we are here leading up, cannot be fully elucidated, however, until chapter 19 and its Appendix have been reached.


VI

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand;─meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product.

In J.S. Mill's Principles of Political Economy the doctrine is expressly set forth:
What constitutes the means of payment for commodities is simply commodities. Each person's means of paying for the productions of other people consist of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange.
As a corollary of the same doctrine, it has been supposed that any individual act of abstaining from consumption necessarily leads to, and amounts to the same thing as, causing the labour and commodities thus released from supplying consumption to be invested in the production of capital wealth. The following passage from Marshall's Pure Theory of Domestic Values[9] illustrates the traditional approach:
The whole of a man's income is expended in the purchase of services and of commodities. It is indeed commonly said that a man spends some portion of his income and saves another. But it is a familiar economic axiom that a man purchases labour and commodities with that portion of his income which he saves just as much as he does with that he is said to spend. (1) He is said to spend when he seeks to obtain present enjoyment from the services and commodities which he purchases. (2) He is said to save when he causes the labour and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future.
It is true that it would not be easy to quote comparable passages from Marshall's later work[10] or from Edgeworth or Professor Pigou. The doctrine is never stated to-day in this crude form. Nevertheless it still underlies the whole classical theory, which would collapse without it. Contemporary economists, who might hesitate to agree with Mill, do not hesitate to accept conclusions which require Mill's doctrine as their premises. The conviction, which runs, for example, through almost all Professor Pigou's work, that money makes no real difference except frictionally and that the theory of production and employment can be worked out (like Mill's) as being based on ‘real’ exchanges with money introduced perfunctorily in a later chapter, is the modern version of the classical tradition. Contemporary thought is still deeply steeped in the notion that if people do not spend their money in one way they will spend it in another.[11] Post-war economists seldom, indeed, succeed in maintaining this standpoint consistently; for their thought to-day is to much permeated with the contrary tendency and with facts of experience too obviously inconsistent with their former view.[12] But they have not drawn sufficiently far-reaching consequences; and have not revised their fundamental theory.

In the first instance, these conclusions may have been applied to the kind of economy in which we actually live by false analogy from some kind of non-exchange Robinson Crusoe economy, in which the income which individuals consume or retain as a result of their productive activity is actually and exclusively, the output in specie of that activity. But, apart from this, the conclusion that the costs of output are always covered in the aggregate by the sale-proceeds resulting from demand, has greatly plausibility, because it is difficult to distinguish it from another, similar-looking proposition which is indubitable, namely that the income derived in the aggregate by all the elements in the community concerned in a productive activity necessarily has a value exactly equal to the value of the output.

Similarly it is natural to suppose that the act of an individual, by which he enriches himself without apparently taking anything from anyone else, must also enrich the community as a whole; so that (as in the passage just quoted from Marshall) an act of individual saving inevitably leads to a parallel act of investment. For, once more, it is indubitable that the sum of the net increments of the wealth of individuals must be exactly equal to the aggregate net increment of the wealth of the community.

Those who think in this way are deceived, nevertheless, by an optical illusion, which makes two essentially different activities appear to be the same. They are fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption; whereas the motives which determine the latter are not linked in any simple way with the motive which determine the former.

It is, then, the assumption of equality between the demand price of output as a whole and its supply price which is to be regarded as the classical theory's ‘axiom of parallels’. Granted this, all the rest follows─the social advantages of private and national thrift, the traditional attitude towards the rate of interest, the classical theory of unemployment, the quantity theory of money, the unqualified advantage of laissez-faire in respect of foreign trade and much else which we shall have to question.


VII

At different points in this chapter we have made the classical theory to depend in succession on the assumptions:
  1. that the real wage is equal to the marginal disutility of the existing employment;
  2. that there is no such thing as involuntary unemployment in the strict sense;
  3. that the supply creates its own demand in the sense that the aggregate price is equal to the aggregate supply price for all levels of output and employment.
These three assumptions, however, all amount to the same thing in the sense that they all stand and fall together, any one of them logically involving the other two.


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