Reconstructing Keynesian Argument - Research Paper Example

 Reconstructing Keynesian Argument Keynes believes that the focus of Classical Economic Theory is too narrowly focused on the theme that price adjustment would automatically account for the demand to reach the maximum employment level. For example, the Classical School of Thought strongly stood with the reason of high and rigid wages for the condition of unemployment, whereas according to Keynes, the matter of wages is much more complex than it seems – wages involve the difference between nominal and real wages with the resulting effects on consumer prices and demand. This focus on the exceptional case (deviating from the general economic concepts) is, according to Keynes, due to the following assumptions of the Classical economists: 1) The Real Wage and Marginal Disutility of the existing labour force is equal (whereas Keynes argues that what wages are actually set are Nominal regardless of what is the prevailing inflation rate), 2) An involuntary unemployment is no concept “as such” (Keynes), 3) In analyzing the Great Depression, it was furthered that supply follows demand when aggregate demand price equals aggregate supply price at all employment and output levels. These are the assumptions that Keynes believed led the Classical Economics to focus on an exception, rather than a general economic scenario. These factors are interrelated, and a fall of one leads to fall of all and vice versa. Keynes’ Theory Identifies the General Condition of Economic Activity Although Keynes deviates from what the Classical economists majorly focus upon, for the reason that he had been surrounded by Classical and Neo-Classical thinkers throughout his life, yet his ideas have a strong reliance to the Classical Thought and form an inspiration from this school of economic thought (Tarshis). Keynes strongly believes that the Classical Economic Theory focused on a specific, exceptional, rather than a general condition of economic theory, namely the strong emphasis on prices and wages as a determinant of the overall employment level of a country. He demonstrated this with respect to the Great Depression, and concluded that the Classical focus was too narrow to apply in general. The Classical economists formulated the concepts which made us to believe that we can drive the economy according to set preferences and likes, but in reality, it is difficult to so influentially affect the various economic forces which alter the real conditions. Hence, according to Keynes, the Classical Economic Theory is not sufficient to explain the general economic conditions. This gave rise to The General Theory of Employment, Interest and Money, which focuses on a general activity, unlike the Classical case. Building upon the concepts of employment, interest and money, Keynes was not just an economist who provided core theoretical concepts, rather he believed in formulation of sound economic policy through the application of those concepts (Johnson). Keynes’ theory therefore was not just focused on one particular direction of economic activity, but actually covered everything from the basics (prices, supply, demand, wages, employment, saving, investment, capital etc.) to actually applying those concepts practically, as economic policies. Not only this, the spending side also has to be kept in mind. Keynes concluded after the World War II that despite many pleads for cuts in excessive spending, while some people followed it, many people carried on their buying patterns (MacGregor, Pigou and Keynes). Classical Economics – Exacerbating Conditions Leading to Crash Rather than Ameliorating According to Keynes, Classical Economic Theory is based on one component – wages. Hence, it comprises of two postulates: 1) The wage equals marginal product of labour 2) Wage’s utility at a given volume of labour employed equals the marginal disutility of that amount of employment (Keynes). The Classical Theory is too narrowly focused on these two postulates, and builds its concepts on these, leading to their cumulative effect on the general employment level. This leads to the ignorance of many related and important factors of the economy, like interest, capital, supply, demand, savings and investment etc. Ignoring these influential aspects makes the economic policy maker to formulate policies that are too naïve. This is where the Classical Theorists’ analysis of the Great Depression went wrong: in assessing the reasons for oversupply and mass unemployment, they only took into account the high- and firm-wage pattern prevalent in the economy. According to Keynes, however, wage behavior is not as easy to discern as said by the Classical economists. The first point in consideration here is that while negotiating for wages, a nominal, not real wage is set between the employers and employees. When real wages fall, a greater fall is felt in real than the nominal, which is already less than what is affordable. Secondly, a fall in prices (and wages) would immediately have a downward spiral effect as a result of people’s falling expectations. Employment, Interest, and Investment need to be theorized According to Keynes, it is mandatory that the economic factors of employment, interest and investment be theorized. This is due to the fact that a sizeable portion of the general economic activity depends on these important factors – in short, the national income of a country. The relative importance of all these factors is inter-dependent and affects each other majorly. This was the prime concern of Keynes – ignoring such important factors was simply not feasible for an economy to work properly. The way the economic factors of employment, interest and investment affect an economy follows a circular fashion: Any country’s income comes from investment and is determined by the income-consumption function. Capital plays a role for the private sector economic activity, and is a major factor in boosting this sector’s contribution (in the form of investment) towards the national economic process. This investment, in turn, is geared upon the marginal productivity of capital and interest rate that is implied upon it. This rate of interest is a function of the liquidity and the amount of money available in the whole economy. The relative significance of the given economic factors, along with their cyclical relation with each other may be noticed from this process. This is why Keynes felt the need of these factors to be properly addressed by theorizing, to include them and consider their important role in the national economic process. Only after these were properly addressed were these factors considered in formulation of economic policy – a move which greatly stabilized the economic system in the world (Gregory, Von Hayek and Plant). Most governments (especially in America and Europe) followed Keynesian economics to formulate policies; hence the success of the capitalist order in the world came about in the post-World War II era. Bibliography Gregory, T. E., et al. "Spending and Saving: Public Works from Rates." The Times 19 October 1932: 10. Johnson, Harry G. "The Early Economics of Keynes." The American Economic Review, Vol. 62, No. 1/2 (Mar. 1, 1972): 416-421. Keynes, J.M. The General Theory of Employment, Interest and Money. New York: Harbinger, 1964. MacGregor, D. H., et al. "Private Spending: Money for Productive Investment." The Times 17 October 1932: 13. Tarshis, Lorie. "An Exposition of Keynesian Economics." The American Economic Review, Vol. 38, No. 2, Papers and Proceedings of the SixtiethAnnual Meeting of the American Economic Association (May, 1948): 261-272. Read More