Wednesday, November 14, 2012

General Theory Study Guide: Chapter 3, Section I

This Chapter introduces the Keynesian concept of "effective demand".  He does so in the most confusing way possible.  I'll try to simplify as much as I can.

In section I, all Keynes does in this section is define "effective demand".  Here's the theory from Keynes's own words.

The amount of employment... depends on the amount of the proceeds which the entrepreneurs expect to receive from the corresponding output.  For Entrepreneurs will endeavor to fix the amount of employment at the level which they expect to maximize the excess of the proceeds over the factor cost.
In other words, Employers will guess what the most profitable level of employment will be, and that is how many people will be hired.  If entrepreneurs don't believe hiring more people will be profitable, they won't hire them.  The point where the cost of employment meets the expected increase in revenue is the point of "effective demand".

Keynes contrasts this with the classical theory(The belief that supply creates it's own demand).  For that belief to be true, any increase in the number of employed people must mean that the cost of hiring will always be less than or equal to the expected profits .  If that were the case, then entrepreneur's would constantly be hiring people until there was no one left and employment really would be determined by the Marginal Disutility of Labor.
Obviously, Keynes doesn't believe the above paragraph is true.  He will lay out his explanation and theory of why in Chapter 3, section II.

Hopefully, my non-math and non-statistical explanation of his definition of "effective demand" will help you understand Keynes's math heavy explanation in Section I.
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