Keynes and the Classics: The Simplest Approach
International Journal of Applied Economics and Econometrics, Vol. 19, No. 1, pp. 1-33, January-March 2011
24 Pages Posted: 25 Mar 2011
Date Written: March 18, 2011
This paper deals with Keynes’ theoretical stance toward classical economics from the viewpoint of effective demand. In the first section, a recap of the pivotal role attributed to overall demand in the dynamics of the business cycle by many economists prior to the “General Theory” is conducted, with special attention to the works of Marshall, Wicksell and Pigou. In the following section, some considerations are presented with respect to Keynes’ original understanding in “The Treatise on Money” of price variations engendered by the differences between saving and investment, followed by an examination of his evolving ideas over the links between saving, income, expenditure and sub-optimal equilibrium output. Next, the processes through which saving and investment were supposed to be equalized in the theories of neoclassical economists such as Robertson, Pigou and Cassel are described in some detail.
In the last section, a diagrammatic presentation of Keynes’ view on the quantitative relationship between investment and consumption within the context of the transformation curve is introduced, in what Keynes called his simplest approach, along with his critique of the full employment assumption made by classical economics.
Keynes’s view is that economics must deal with economic relationships which are non linear and non additive at both the micro and macro levels. Classical (neoclassical) economics assumes linearity and additivity in economic relationships at both the micro and macro levels. Keynes’s strategy was to maintain linearity and additivity in his multiplier model but introduce non linearity and non additivity, in order to account for the impact of uncertainty as opposed to risk, in his elasticity analysis in chapter 21. This analysis was based on the integration of expectations into a microeconomic foundation of purely competitive firms operating with one fixed input and one variable input that Keynes accomplished in chapter 20.
We demonstrate how Keynes could have introduced non linearity and non additivity into his multiplier model in an appendix. We relate this to the modern approach to decision theory that is based on capacities.
Keywords: Keynes, Uncertainty, Expectations, Capacities
JEL Classification: B12
Suggested Citation: Suggested Citation