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Origin of the Idea
John Maynard Keynes (1883-1946) argued that there was a "fundamental psychological law" concerning the relationship between income and consumption: The fundamental psychological law, upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, is that men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.(1) As you know from the text, the consumption function is a primary building block of the Aggregate Expenditures model. John Maynard Keynes was, arguably, the most influential economist of the 20th century. His seminal contributions to macroeconomic theory, his philosophical shift from the conservative neoclassical mainstream in economics, and the sheer number of economists and policy-makers who bore his banner, all serve to make Keynes a leading economic figure. Keynes was destined to a life of intellectual pursuits from the very beginning. His mother served as a justice of the peace, an alderwoman, and the mayor of Cambridge. His father, John Neville Keynes, was an accomplished logician and political economist. John Maynard Keynes studied at Cambridge under the guidance of prominent economists Alfred Marshall (1842-1924) and A.C. Pigou (1877-1959). Following his studies at Cambridge, he became editor of the Economic Journal, and successfully managed the investments of the Royal Economic Society, its publisher, and King's College of Cambridge, as well as his own. Keynes was a speculator, but interestingly, had this to say about speculators: Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism – which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object.(2) Keynes was a prolific writer and a prominent social and political figure. He was the main representative of the British Treasury at the peace conference after World War I, given the power to speak for the chancellor of the exchequer. He was highly critical of the Paris negotiations and the eventual Treaty of Versailles, causing him to resign his position in 1919 and begin writing The Economic Consequences of the Peace, published in 1920. In this work he predicted that the reparations imposed on Germany were excessive and would lead to political and economic conditions conducive to future armed conflict. He also served as trustee of the National Gallery, chairman of the Council of the Encouragement of Music and the Arts, chairman of the Nation and New Statesman magazines, and chairman of the National Mutual Life Assurance Society. He organized the Camargo Ballet (his wife, Lydia Lopokova, was a renowned star of the Russian Imperial Ballet), and built the Arts Theatre at Cambridge. Keynes published The End of Laissez-Faire in 1926. While not his best known work, it did clearly articulate his feelings about capitalism and establish his philosophy that government involvement was necessary to bring about long term economic security. Keynes believed laissez-faire capitalism resulted in significant inequalities of wealth, excessive unemployment, and inefficiency:
Keynes' magnum opus was The General Theory of Employment, Interest, and Money, published in 1936. Writing in response to the Great Depression and the seeming impotence of classical economic theory to provide a solution, The General Theory articulates most of the economics of Keynes that would later evolve into the theories we recognize today. The Economics of Keynes v. Keynesian Economics It should be noted that while Keynes' writing provided inspiration for a number of economists who would come to be known as Keynesians, many of the well-known theories bearing his name were not developed by Keynes himself. For example, the IS-LM model, a Keynesian model you are likely to see in an intermediate macroeconomics course, was the result of work by Alvin Hansen (1887-1975) and John R. Hicks (1904-1989).
As economists do today, John Maynard Keynes (1883-1946) distinguished between economic investment (the purchase of capital goods) and financial investment (the purchase of stocks, bonds, and other financial assets). Economic investment was the focus of Keynes' theory. He claimed that firms will invest in new capital when the expectation of earning profit from that capital is positive. As Keynes put it, when a firm invests, it "purchases the right to the series of prospective returns, which [it] expects to obtain from selling its output, after deducting the running expenses of obtaining that output, during the life of the asset."(1) The potential profitably of an investment, according to Keynes, depends on the replacement cost of the capital, the expected returns from that capital, and the cost of borrowing (the rate of interest). If the expected returns (referred to as the marginal efficiency of capital) from an investment exceed the rate of interest, we would expect the firm to make the investment. John Maynard Keynes was, arguably, the most influential economist of the 20th century. His seminal contributions to macroeconomic theory, his philosophical shift from the conservative neoclassical mainstream in economics, and the sheer number of economists and policy-makers who bore his banner, all serve to make Keynes a leading economic figure. Keynes was destined to a life of intellectual pursuits from the very beginning. His mother served as a justice of the peace, an alderwoman, and the mayor of Cambridge. His father, John Neville Keynes, was an accomplished logician and political economist. John Maynard Keynes studied at Cambridge under the guidance of prominent economists Alfred Marshall (1842-1924) and A.C. Pigou (1877-1959). Following his studies at Cambridge, he became editor of the Economic Journal, and successfully managed the investments of the Royal Economic Society, its publisher, and King's College of Cambridge, as well as his own. Keynes was a speculator, but interestingly, had this to say about speculators:
Keynes was a prolific writer and a prominent social and political figure. He was the main representative of the British Treasury at the peace conference after World War I, given the power to speak for the chancellor of the exchequer. He was highly critical of the Paris negotiations and the eventual Treaty of Versailles, causing him to resign his position in 1919 and begin writing The Economic Consequences of the Peace, published in 1920. In this work he predicted that the reparations imposed on Germany were excessive and would lead to political and economic conditions conducive to future armed conflict. He also served as trustee of the National Gallery, chairman of the Council of the Encouragement of Music and the Arts, chairman of the Nation and New Statesman magazines, and chairman of the National Mutual Life Assurance Society. He organized the Camargo Ballet (his wife, Lydia Lopokova, was a renowned star of the Russian Imperial Ballet), and built the Arts Theatre at Cambridge. Keynes published The End of Laissez-Faire in 1926. While not his best known work, it did clearly articulate his feelings about capitalism and establish his philosophy that government involvement was necessary to bring about long term economic security. Keynes believed laissez-faire capitalism resulted in significant inequalities of wealth, excessive unemployment, and inefficiency:
Keynes' magnum opus was The General Theory of Employment, Interest, and Money, published in 1936. Writing in response to the Great Depression and the seeming impotence of classical economic theory to provide a solution, The General Theory articulates most of the economics of Keynes that would later evolve into the theories we recognize today. The Economics of Keynes v. Keynesian Economics It should be noted that while Keynes' writing provided inspiration for a number of economists who would come to be known as Keynesians, many of the well-known theories bearing his name were not developed by Keynes himself. For example, the IS-LM model, a Keynesian model you are likely to see in an intermediate macroeconomics course, was the result of work by Alvin Hansen (1887-1975) and John R. Hicks (1904-1989).
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