Keynes, Pigou, and the Microeconomic Foundations of the General Theory: The Marginal Productivity Theory of One Variable Input (Labor) and One Fixed Input (Capital)

Abstract:     
Keynes chose to base the General Theory on the same type of microeconomic foundations that are contained in A C Pigou’s The Theory of Unemployment (1933), Part II, Chapters 8-10. This allowed Keynes to make a direct comparison - contrast between the two models in the appendix to Chapter 19. Pigou used the standard short run, marginal productivity theory of one variable input, labor, and one fixed input, capital. Keynes himself expressed reservations about this type of micro foundation. He voiced his reservations in his “digressions” chapters in the General Theory (Chapter 4, 5, 6, and 7; these reservations are summarized on pages 272-273 of the appendix to Chapter 19). These digressions (Chapter 4 on the issue of the homogeneity versus heterogeneity of output and capital goods and Chapter 6 on User Cost) were issues concerning how to measure actual physical output and capital goods for inclusion in GNP statistics, as well as how to account for inter and intra industry purchases between firms at the microeconomic level only. These digressions had no theoretical importance at the macro level and would not prevent or hinder a theoretical discussion of aggregated behavior once suitable aggregation assumptions had been made. Keynes, like Pigou, explicitly made such assumptions. This enabled Keynes to define all of the relevant functions needed for an aggregated macroeconomic analysis to be functions of a single variable input, labor, N,with the capital stock being held fixed in the short run. The formal analysis of the Theory of Effective Demand would proceed using Z=phi(N) and D=f(N). All of the technical analysis would be based on derivatives and elasticities involving ratios of a marginal function (a derivative) to an average function. No partial derivatives appear anywhere in the General Theory. The use of partial derivatives would have been needed if Keynes were to have made output a function of two variable inputs, labor and capital.

Number of Pages in PDF File: 31

Keywords: D, Z, Aggregte Supply Curve, Marginal Productivity Theory

JEL Classification: E12

Accepted Paper Series