J M Keynes's IS-LP(LM) Model Is the Central Message of the General Theory.the IS-LP(LM) Model Is Built and Rests on a Foundation of the Theory of Effective Demand's D-Z Model of Chapters 3,20 and 21 and Keynes's a Treatise on Probability's Concept of 'the Weight of the Evidence'
38 Pages Posted: 20 Oct 2017
Date Written: October 20, 2017
The Central Message of the General Theory is based on Keynes’s macroeconomic analysis and discussion of his IS-LP(LM) model. Keynes showed how the model determined the rate of interest in chapters 13,14, and 15. Keynes extended the range of assets considered from money and bonds to all assets in chapters 16 and 17. Keynes then brought all of the elements of his general theory together in chapter 21 of the General Theory. Keynes supported this overarching theory with a microeconomic foundation based on the theory of purely competitive firms that integrated expectations about future price and expected future profits. Keynes denoted this analysis as the D-Z Theory of Effective Demand. The D-Z model analysis in chapter 20 of the General Theory leads to Keynes’s construction of an Aggregate Supply Curve, which is a locus or set of all possible optimal, expected D-Z intersections that satisfy the necessary and sufficient first and second order conditions for a profit maximum. Only one of these D-Z intersections will be actually realized. This realized outcome Keynes called Y. Y is then combined with r, the rate of interest, to form (r,Y) space to show how the rate of interest is determined by BOTH the IS equation and the LP(LM) equation,both of which are functions of Y and r.
Uncertainty is then incorporated into the IS-LP(LM) model by first defining uncertainty to be a function of the weight of the evidence ,as discussed in chapters 6 and 26 of the A Treatise on Probability, and then defining Liquidity Preference to be a function of uncertainty. Thus, an increase in uncertainty,or a decline in the weight of the evidence or confidence ,will shift both of the IS and LP(LM) equations.
The economics profession has been very badly mislead by the oral claims ,which have been made with no factual backing, made by Joan Robinson about the General Theory. One of Robinson’s claims was that Keynes was a partial equilibrium, Marshallian, anti-formalist theorist, who would “burn” the mathematical analysis after it had been used by Keynes to verify his elegant prose.This claim, accepted by all Post Keynesians, Carabelli, Backhouse, Dimand, Rubin, Hoover, Laidlar,and many others, is directly contradicted by Keynes’s mathematical analysis in chapters 10, Section IV of chapter 15, the appendix to chapter 19, chapter 20 and chapter 21.
We are left with the following truly bizarre conclusion - Keynes eliminated the formal, mathematical, simultaneous four equation structure of his IS-LP(LM) model, but kept the mathematics of his Theory of Effective Demand in the General Theory in chapter 20 that supported the macroscopic IS-LP(LM) model of chapter 15, section Four, that was used to demonstrate the special case nature of neoclassical economics when Liquidity Preference was removed.
Keywords: Harrod, Hicks, Keynes, IS-LM, Liquidity preference, QJE 1937, chapter 15, pp.180-182 of GT, chapter 21
JEL Classification: B10, B12, B14, B16, B20, B22
Suggested Citation: Suggested Citation