Monday, August 27, 2012

General Theory Study Guide: Chapter 2, Sections VI and VII

In Section VI, Keynes gives "Classical Economics" a final blow.  He starts to build his case that Money has an effect on the way an economy works.  The thought that the principles of a barter economy can be applied to a monetized economy was strong.  In fact, it is still strongly believed by Austrian Economics that barter is a useful model for monetized economies.

Keynes starts off section IV by quoting John Stuart Mill and Alfred Marshall.  This is to demonstrate the current thought which is that "supply creates it's own demand" as presumed by Mill.  The Marshall quote goes to show that the belief really is that if a person abstains from spending his income, it somehow automatically triggers a corresponding investment by himself or others.  Keynes claims this is incorrect because the two are using a false analogy between the world in which we live(a monetized economy) and a Robinson Crusoe economy of pure barter.

Keynes makes  a couple guesses as to why people have made this mistake.  The first is the strong case of Says law.  He agrees with the premise that the "income"(things it gets) of an entire community is exactly equal to it's "output"(things it makes).  This concept is confused with a (what Keynes calls a "similar-looking") proposition: "the costs of output are always covered in the aggregate by the sale-proceeds resulting from demand".  So what does that mean?  I found someone who explained it simply:

That is, I do not decide how many ipods will be made this year, but I do decide whether I want to buy one. Apple has to guess whether or not I will buy.
His other guess as to why people make this mistake is that those who believe Say's laws are basing it on individuals.  If an individual "saves" he is richer.  If every individual in the community "saves" then shouldn't the whole community be richer?  Keynes doesn't think so since.  This is his first hint at his fallacy of composition argument.

The two most important concepts from this section are:
1. Money matters.  It changes the way an economy works.  Money is not a "thing veneer" over a pure barter economy.
2.  The "classicals" are "fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption."
This leads Keynes to declare that many theories of "the classicals" need to be re-examined.

Section VII
Section VII is a summary of the rest of the chapter.  Keynes summarizes the 3 biggest ideas of the classical economists(seen below) that he believes are flat out wrong.  The following ideas must all be true, or all not true.
  1. The real wage is equal to the marginal disutility of the existing employment;
  2. There is no such thing as strictly involuntary unemployment;
  3. supply creates its own demand
Leave a Comment