Chapter 3

The General Theory's Propositions

by John Maynard Keynes Icon
  1. Resources and costs, income (both money-income and real income) depend on the volume of employment N

  2. The relationship between the society’s Income and its Disposable Income , will depend on the society’s propensity to consume.

Consumption depends on Aggregate Income and, therefore, on the level of employment N, except when there is some change in the propensity to consume.

  1. The amount of labour N which the entrepreneurs employ depends on Effective Demand which is made up of:
  • Disposable Income for Consumption
  • Disposable Income for Investment .
  1. Disposable Income for Consumption + Disposable Income for Investment = Effective Demand = φ(N)
  • φ is the aggregate supply function

Item 2 shows that Disposable Income is a function of N which we may write χ(N). Depending on the propensity to consume, it follows that

Aggregate Income(N) - Disposable Income(N) = Disposable Income for Investment
  1. The equilibrium volume of employment depends on:
  • the propensity to consume χ [this leads to demand]
  • the volume of investment D2 [this feeds the supply]
  • the aggregate supply function φ [this feeds demand]

This is the essence of the General Theory of Employment.

  1. The real wage is determined by the marginal productivity of labour in the wage-goods industries for every value N [employment level].

At the equilibrium volume of employment, N [employment level] cannot exceed the value which reduces the real wage to slave wages .

This means that not all changes in Effective Demand leads to constant money-waves.

  1. The classical theory believes that:
Effective Demand = Aggregate Supply of Employment [demand is equal to supply]

The volume of employment is in a neutral equilibrium for all the possible levels of employment N when this volume is less than its maximum value that the competition between entrepreneurs push it to this maximum value.

According to the classical theory, stable equilibrium can only be achieved at this point.

  1. When employment increases, Disposable Income will increase, but not by so much as Effective Demand .
  • This is because when our income increases, our consumption increases also, but not so much. [more employment leads to more savings]

The more the employment, the more will be the gap between:

  • the Price Levels and
  • the Disposable Income for Consumption which entrepreneurs can expect to get back.

Hence, if there is no change in the propensity to consume, employment cannot increase unless at the same time Disposable Income for Investment is increasing.

  • This would fill the increasing gap.

The classical theory thinks that there is some force* which, when employment increases, always causes the Disposable Income for Investments to increase enough to fill the widening gap between Price Level and Disposable Income for Consumption .

*Superphysics Note: This is the absolute demand from Adam Smith, which is not present in Ricardo nor any other economist. This absolute demand is killed by profit maximization embodied in the Disposable Income for Investement. Economic Superphysics aims to counteract profit maximization through barter. There is no mention of barter anywhere in Keynes’ General Theory

On the contrary, I believe that the economy can be in stable equilibrium with N [employment level] below full employment* (the intersection of the aggregate demand with aggregate supply).

*Superphysics Note: This is underemployment where people work in 2 jobs to address the rising price levels which are caused by investors squatting on investments.

Thus, employment is not determined by slave wages measured in terms of real wages, except when the supply of labour available at a given real wage sets a maximum level to employment.

Instead, the volume of employment is determined by:

  • the propensity to consume [demand] and
  • the rate of new investment*

*Superphysics Note: Keynes adds the importance of investors when the Classical system did not give them special emphasis

The volume of employment is determined by the level of real wages, not the other way round.

If the propensity to consume and the rate of new investment result in a deficient effective demand, then:

  • many people will be unemployed at the current real wage.
  • the equilibrium real wage will be greater than the slave wages of the equilibrium level of employment

This explains the paradox of poverty in the midst of plenty.

The shortage of effective demand often will:

  • halt the increase of employment before a level of full employment has been reached.
  • inhibit the process of production even if the marginal product of labour still exceeds the marginal disutility of employment in value.

Moreover, the richer the society, the wider will be the gap* between its actual and its potential production [because the rich are not demanding more].

  • This will lead to more obvious and outrageous defects of the economic system.

*Superphysics note: In Economic Superphysics, this is addressed by 2 state funds, an investment fund and a clearing fund. The investment fund is a mini sovereign wealth fund that funds investments in industries that create basic necessities. The clearing fund provides trade financing. These close the gap in effective demand and absorb idle money.

A poor society will be prone to consume more of its output [have high effective demand].

  • This makes a very modest investment enough to provide full employment.

Whereas, a wealthy society will have to find better opportunities for investment* if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members.

*Superphysics note: This is because profit and rent maximization is more acute in a wealthy society

If the inducement to invest is weak in a potentially wealthy society, then the effective demand will be lower.

  • This will compel it to reduce its actual output until it becomes so poor that its surplus over its consumption is reduced to match the weak inducement to invest*.

*Superphysics Note: This weakness is caused by the doctrine of profit maximization

The marginal propensity to consume[6] will be weaker in a wealthy community.

  • But its accumulation of capital is larger.

The opportunities for further investment are less attractive unless the interest rate falls* rapidly.

  • This brings us to my theory of interest rates.
  • It explains why interest rates do not automatically fall to the appropriate level. Book 4 will discuss this.

*Superphysics Note: In Classical Economics, falling interest rates mean that profit rates are also falling. Keynes wrongly assumes that artificially low interest rates will drive investments. He fails to realize that investment has been corrupted by profit maximization which renders his solution impotent. The focus is only for Marginal Effciency of Capital

Thus, 3 main gaps in our existing knowledge are:

  1. The analysis of the Propensity to Consume
  2. The definition of the Marginal Efficiency of Capital
  3. The theory of the Rate of Interest*

*Superphysics note: This is really the fallacy promoted by Keynesian doctrine

The Theory of Prices is subsidiary to our general theory. Money plays an essential part in our theory of the Rate of Interest.


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