John Maynard Keynes Contribution to Macroeconomics - Term Paper Example

? JOHN MAYNARD KEYNES CONTRIBUTION TO MACROECONOMICS Macroeconomics 4/24 Keynes General theory John Maynard Keynes is a very prolific contributor to modern macroeconomics. He played a very big role in the development of macroeconomics theories that are in use up to date. Keynesian general theory of macroeconomics states that in the short run, economic output is strongly influenced by aggregate demand. Keynes also said that the total economy expenditure is not a reflection of its productivity. Keynes states that in order for aggregate supply to meet aggregate demand, the goods supplied should be those that are in demand. All these above theories he made when launching his book in 1936 “the general theory of employment, money and interest.” Keynes believed that the classical approach to macroeconomics was erroneous and had been interfered with by the outbreak of world war one. He also believed that the classical approach’s belief that the balance between supply and demand would ensure employment for everyone was false. This was caused by inadequate investment and the psychology held by many people about saving. People had fear of investments due to the looming uncertainties caused especially by the war. The classical approach had thus grown absurd and this is why John Keynes embarked on the project to come up with new economic theories to save the situation. The solution that Keynes brought to the above problem of the private fear of investment was to bring in public investment from the government albeit on deficit spending. This would in turn create jobs and soon the government would pay off their debts. This therefore laid a foundation for macro- economics as it viewed the entire economy as one focusing on the government’s role in the economy as a whole. His research helped come up with ways that were used to measure an economy’s productivity. This was in terms of Gross Domestic Product (GDP) and Gross National Product (GNP), which were in terms of expenditure, deficits and taxes which if managed effectively could lead to full employment. Keynes therefore envisioned active participation by the government. He thus played a big role in convincing governments to participate in economic issues. He always deemed the government to be superior in matters affecting the market and economy. How Keynes went against say’s law Jean-Baptiste Say, a French man had earlier come up with a theory of his own. This theory stated that it is impossible for supply to outrun demand as supply is brought about by demand any way, which was part of one of the classical approaches to macro-economics that tried to explain the reasons behind recessions and depressions. Say stated that the main cause of a glut (overabundance of a product in the market) is the producer’s illiteracy on the nature of the demand. Another scholar - David Ricardo, furthered this argument to state that recessions are caused by overproduction of goods that are not what the customers wanted. Goods are therefore not sold because the goods produced are not what the customers wanted. Customer satisfaction is a key factor in matters production; therefore, a product cannot be bought if it does not satisfy customer requirements. Keynes misinterprets Say’s law by saying that supply creates its own demand; this in essence interprets the law to state that whatever will be produced will be consumed which is not the case. Keynes omits the fact that in order for aggregate supply to meet the aggregate demand, the goods supplied must be those that are demanded by the market. This is how Keynes basically went against Say’s law. Keynes therefore, in his book “the general theory” states that deficiencies in demand are the main cause of economic recessions. The great misinterpretation of Keynes in Say’s laws was what created his legacy up until more economists came up and deduced the above as they made his theory not hold anymore. Economists nowadays have thrown almost all of Keynes theories out of the window and made new gains in the field of macro-economics. Keynes view on government intervention during a recession or depression Keynes had an opinion that all governments have an upper hand or insider information about market trends. He believes that only governments can curb the investments deficit caused by the stereotypes on saving and investment that not being exploited by the private sector. Recessions according to Keynes are caused by an overflow of products in the market that are not in demand, which weakens the purchasing power of consumers in general. The subsequent events brought about by a recession include high unemployment rates, reduced level of cash-flow in the economy, net export activity and incomes of employees. The above is basically a significant decline in economic activities that is felt throughout the economy. If this however persists for a number of years (three to four), the economy can be said to be in an economic depression. Another type of despair is when there is a severe drop of the gross domestic product by 10%. Keynes believes that the government has the power to stop the slow- down of economic activities even if it means that it is to use deficit funding. The government has ability to easily acquire loans from anywhere be it allies or the IMF (International Monetary Fund) world bank. These finances can then be used to strengthen the economy and increase the rate of cash-flows in the economy which is on a go slow. The first step to this is to create employment opportunities to the people of the country so as to increase productivity of the citizens. Classical economists believed earlier on that a market economy could automatically tend to provide full employment to a country’s citizenry. This remained the case up until the great economic depression. They had inquire the legitimacy of the above question due to the looming unemployment in the economy. Since the classical economists had accepted Say’s law of demand attracting supply they expected the economy to grow up to a point where it could accommodate full employment for the citizenry. The above could not be achieved due to the phenomenon of saving; the idea of employees earning an income and instead of using it to buy from the very same industries that are employing them and giving them the very same salary, they saved led to Say’s law becoming obsolete. This is because saving of money instead of it flowing will only lead to a glut in the markets since some products produced are not being sold to the fullest. This will force the companies to go on a production go slow since their products are not selling. The immediate effect of this is that most workers will be non-productive in organizations thereby forcing the top management to retrench them. Unemployment will be on the rise and eventually a recession. Keynes thus sees it to be the duty of the government to combat inflation or unemployment. He argued that the government had the ability to control its own spending and taxation on the citizens to direct the economy’s performance. The government’s move to reduce their spending will reduce aggregate demand hence inflationary pressures will be reduced as well. The government could also set monetary policies to alter the money supply in the market so as to alter the total expenditure and the economy’s performance; the government should do via the Federal Reserve which determines the amount of money that is in circulation in the economy. He finally argued that unlike the classical approach where the economy was supposed to provide full employment to the citizenry, the economy can only provide unemployment equilibrium which involves a stable level of output in the economy that is not large enough to permit full employment of the citizenry. To some extent Keynes was right about the role which the government had to play in reducing the problems brought about by economic recessions and depressions in as much as economists nowadays are against his work. The classical economists however, adamantly favor the policy if laissez-faire which involves the government not interfering with the economy as they believe it has the ability to sustain itself. Aggregate demand and Aggregate supply Aggregate demand refers to the total request of a product in the market. The same is true for aggregate supply as it refers to the total supply of a product in the markets. The aggregate demand is mainly affected by the consumers in a market and they are according to Say’s theory, the aggregate supply is fuelled by aggregate demand in an efficient market. Keynes macro-economic insights Keynes helped to develop the measures of economic performance used to date. These include Gross Domestic Product (GDP) and Gross National Product (GNP) which are the most popularly used in macroeconomics. This is because they have a wholesome view of the whole economy. The GDP is a measure of the total economic output of a country regardless of whether those living in it are nationals or foreigners. The GNP contrary is a measure of the gross economic performance of a country’s nationals whether living in the country or in the diaspora. The GDP of a country is measured from the total income sent to households by companies. This will however have to subtract an allowance called leakage which refers to the savings kept aside by the households. The leakage that is lost to savings should however be replaced in order for the economy to be in equilibrium. This therefore means that there should be extra cash-flow into the economy which ideally comes from industries. This cash-flow is referred to as an injection and it should be equal to the leakage from the economy. Keynes also stated that interest rates adjustments should not be used as a basis of comparing interest rates to since they are not the major motivating force behind the saving or the investment decision. He therefore made the argument of interest to be used to fill leakage obsolete in matters GDP. Keynes view on how to fix unemployment Keynes strongly believed that the government still had the key to solve unemployment through monetary and fiscal policies as seen earlier above. Monetary policies which he suggested were for the Federal Reserve to increase the amount of money in circulation at any one time there is a threat of unemployment which may lead to a recession or perhaps beat the odds and go to a depression. This move is aimed at making credit facilities available for those unemployed, so as to increase employment opportunities by self- employment. Self-employment can lead to further creation of employment opportunities. Keynes also argues that it is not uncommon to find workers who are voluntarily unemployed. This is due to the high unrealistic salary demands that they have posed to their prospective employers. Such are the dilemmas that face employers as hiring such people will not make sense to them as they will be running on losses. Employers thus get equally qualified or less qualified employees for the same job yet there exists a qualified person out there in the job market. A simple decision by trade unions of workers in a certain sector to cut on their respective salaries in order to accommodate more employees and as such create job opportunities could go a long way in reducing unemployment as argued by Keynes. This he however found to be almost impossible due to the formation of trade unions especially in strong labor markets which many-a-time help the workers in protesting against wage cuts. Keynes also argues that there exists a group of involuntarily unemployed workers who did not have any choice but wait for employment without much of a choice of the salary they get paid. This could be perhaps due to lack of qualifications required for the available jobs. This is in contrast to the classical model, which suggests that at equilibrium there is full employment. If the economy is drifting toward equilibrium and there is no full employment then there exists an unemployment equilibrium. Bibliography Adam Martin 2004 Keynes and Say’s Law of Markets: Analysis and Implications for Austrian Economics. Daniel Yergin and Joseph Stanislaw, 1998 The Commanding Heights. http://www.econlib.org/library/keynes.html Read More