They believe that prices and wages are sticky, especially downward. It is only in the intermediate situation between these two extremes that money is non-neutral. But the propensity to consume depends upon the psychology of the people, their tastes, habits, wants and the social structure which determine the distribution of income. In this way, his analysis does not take into account the impact of international trade on the growth of employment and income of the economy. In other words, the economy is always capable of demanding all of the output that its workers and firms choose to produce. Autonomous investment is taken as a first approximation.
C and Y rise and fall together. The rate of interest is determined by the demand for money and supply of money. Gordon Fletcher deemed it a 'myth' that 'saving finances investment': Keynes attacked the widespread belief that investment is somehow financed by saving. But, in the long-term, when wages adjust, unemployment will return to the natural rate, and there will be higher inflation. This makes his theory inapplicable to socialist or communist societies where the entire economy is regulated by the state. The producers of these goods will now have extra incomes.
The aggregate demand price exceeds the aggregate supply price or vice versa at some levels of employment. It is only a medium that bridges the gap between receipts and payments. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. In fact there do exist obvious reasons to consider it absurd, but they are of no help to Keynes. However, when the amount of sales receipt increases, the organization starts employing more and more workers.
This draws a line somewhere around the middle of the list and seems to be the assumption made by , who commented that: It almost seems as if the money which is saved is completely distinct from the money which is lent and borrowed, and that the former, if it ever reaches a bank, or any lending agency, is still kept entirely separate. In fact, aggregate demand in the economy is the driving force that determines the level of output, employment and income. For similar reasons Keynes sees justice in scholastic prohibitions of usury. Expandable market size The size of the market is considered flexible that are easily expandable with the increase in the volume of products that are being produced and offered for sale in the market. Thus the amount held under these two motives M 1 is a function L 1 of the level of income Y , i. When the entrepreneurs find that their receipts are less than their costs, they will stop offering employment to new workers.
During 1929-33 there was a world-wide depression. Role of money Keynes rejects the idea that money is only a medium of exchange and states that money has a greater role in the economy such as determination of income, output, and employment. He considers that demand arising from the first two motives 'mainly depends on the level of income' p199 , while the interest rate is 'likely to be a minor factor' p196. Aggregate supply is the total of commodities supplied in the economy. It has to take money away from the people and companies to spend it. After the full employment level is reached i.
There are three motives on the part of the people to hold cash: a Transaction demand for money, b Precautionary demand for money, and c Speculative demand for money. Higher taxes for businesses take money away that could otherwise be spent on more investments to grow the company. According to Professor Schlesinger, the Keynesian theory of aggregate demand suffered from certain inherent defects which made his theory of employment unrealistic. Investment depends upon the marginal efficiency of capital and the rate of interest. It is assumed that the money that flows into the economy is not hoarded by any economic units as it is used either for consumption or investment. For when we look upon the Multiplier as an instantaneous functional relation. This is the basic difference between Classical Theory and Keynesian Theory.
Difference in policy recommendations 1. Business owners have to use the actions of politicians and business leaders as signposts to help them make their own decisions about the growth of their companies. According to this theory, this affects wages and the employment rate. Thus employment is based on aggregate demand which in turn is ascertained by consumption demand and investment demand. The lower bound is attained under a pre-Lavington classical model in which interest has no effect on liquidity preference, and the upper bound under the Chapter 13 theory in which income has no effect; in general the position of κ between the extremes will depend on the relative magnitudes of the two influences. In Figure-3, point E represents the equilibrium level of employment because at this point, the aggregate demand curve and aggregate supply curve intersect each other. Keynes describes the process by which the level of employment adapts to a change in long-term expectations and remarks that: the level of employment at any time depends.
As a result, employment and income will also rise. Whether Keynesian or classical economists are correct in their views cannot be determined with certainty. Keynes states as a 'fundamental psychological law' p96 that the marginal propensity to consume will be positive and less than unity. A certain minimum amount of price is required for inducing employers to offer a specific amount of employment. They believe short-term problems are just bumps in the road that the free market will eventually solve for itself.