J M Keynes's Main Argument in the General Theory Is Not Expressed in Terms of His Aggregate Demand (D) and Aggregate Supply (Z) Model. Keynes's D-Z Analysis Supports a Specific Y=C plus I, Marginal Propensity to Consume, Income Expenditure, Investment Multiplier Result (I=S) that Keynes Combined with His Liquidity Preference Function (L=M) to Determine the Rate of Interest in His IS-LP (LM) Model
30 Pages Posted: 7 Nov 2017 Last revised: 30 Dec 2017
Date Written: November 5, 2017
Keynes’s Theory of Effective Demand model of Expected Aggregate Demand (D) and Expected Aggregate Supply (Z) was used by Keynes to construct the Aggregate Supply Curve (ASC), which is a locus of the set of all possible expected D=Z equilibrium results that satisfy the necessary and sufficient first and second order conditions for an expected profit maximum in the output market. Only one D=Z combination will be optimal and provide a full employment level of output at non inflationary levels so that there will be no involuntary unemployment in the labor market. All other equilibriums from the ASC will not provide a full employment level of output at non inflationary levels. There will be some amount of involuntary unemployment that will show up as a disequilibrium in the labor market. Only one of the set of D-Z equilibriums will be the actually realized result. This actually realized value of D (=D1 plus D2) is called Y by Keynes. This gives a specific actual, realized Y=C plus I, marginal propensity to consume, Income expenditure, Investment Multiplier result (I=S) that Keynes combined with his Liquidity Preference Function (L=M) to determine the Rate of Interest in his IS-LP (LM) model of chapters 15 and 21. Thus, the IS-LP (LM) model is primary while the D-Z model is secondary. Both models are needed since Y, aggregate Income, is used in the IS-LP (LM) model. Y is provided by the D-Z model.
The Neoclassical Synthesis Keynesians have correctly emphasize the IS-LP (LM) model as being the major result of the General Theory, but overlooked that it was Keynes, and not Hicks, Harrod, Meade or anyone else, who originated, taught, developed and applied the IS-LP (LM) model. However, the Neoclassical Synthesis Keynesians have also overlooked the full D-Z model provided by Keynes in chapter 20 of the General Theory and concentrated on chapter 3, which has no D-Z analysis in it.
The Post Keynesians have, incorrectly, ignored Keynes’s IS-LP(LM) model, painstakingly constructed sequentially by Keynes in chapters 10, 11, 13, 14, 15, 16, 17, and 21 and concentrated on the introductory chapter 3 of the General Theory alone, which only contains a brief outline of the D-Z model. Keynes fully develops the D-Z model in chapters 20 and 21 of the General Theory. What Keynes did in chapters 19-21 is ignored by the Post Keynesians.
Thus, Keynes’s complete contribution in the General Theory, which involves both the IS-LP (LM) model and the D-Z model, has never been acknowledged. This is the result of the vast confusion about “What did Keynes really mean in the General Theory” that can be traced to three main sources-Joan Robinson, Austin Robinson, and Richard Kahn.
Keywords: Harrod, Hicks, IS-LM, Liquidity preference, Patinkin, chapter 15, pp.180-182 of GT, chapter 15, chapter 21
JEL Classification: B10, B12, B14, B16, B20, B22
Suggested Citation: Suggested Citation