John Maynard Keynes and His Contribution to Economics - Essay Example

John Maynard Keynes and his Contribution to Economics John Keynes is a renowned and influential economist in the twentieth century although he began his works in the nineteenth century and developed them in the twentieth century. John was born in a family of three in Cambridge in 1883. While in school, Keynes specialized in economics and mathematics, and this made him to develop theories that are still applicable in economics. The theories include the theory of employment, interest, money, and wages. Keynes also proposed for governments to intervene in the market using monetary and fiscal policies (Keynes, Johnson and Moggridge 34). Keynes’s contributions are widely accepted and they are used in economic theory to study income, employment, and wages. This paper will analyze the life of John Keynes, the contributions that he has made to economics, and their impact in economic theory. The life of Keynes Keynes was born in a family of three in 1883 in Cambridge. The father of Keynes who was known as Neville Keynes was an author and a reformist while his mother undertook various roles such as being the mayor of Cambridge for a term. Keynes’s father wrote books such as formal logic, which was famous in Cambridge College where he taught for some years (Eatwell and Milgate 27). Neville Keynes was also a close friend of Alfred Marshall who is also a renowned economist of the nineteenth century. John’s history indicates that he did not adhere to any religion while he grew up meaning that his life and works were not influence by any faith. John Keynes won various study scholarships during his school times. One of the scholarships that Maynard won was at Eton School in England where he finalized his high school. The next scholarship that the economist won was in Cambridge, at King’s College where he focused on mathematics and became the twelfth best in the school in his final year (Coddington 18). Although Keynes specialized in mathematics while studying at King’s College, he had a powerful interest in politics. The political interest made Keynes to study Economics under the guidance of Alfred Marshall who was his father’s friend and Arthur Pigou after he finished college in Cambridge (Coddington 20). After he finished school, Keynes got employed at the Indian Treasury where he studied the behaviour and trend of the Indian Currency. Keynes used his knowledge and skills to solve problems that were associated with the Indian Currency while working in the Finance Department. Keynes’s expertise at the Indian Finance Department won him a job as an adviser to the Finance Department of Britain where he served from 1915 to 1919 during the First World War (Keynes, Johnson and Moggridge 42). Keynes contributions to economics began when he studied and published a study on probability in 1921. The work was known as The Treatise on Probability. In this work, Maynard argued that a flexible exchange rate and stable prices were the main factors that lead to the success of an economy. Keynes continued studying and writing economics books such as The General Theory of Employment, Interest, and Money that was published in 1936 (Keynes 29). This book won Keynes an award at the House of Lords in Sussex where he was known as Tilton Keynes (Coddington 49). Unfortunately, Keynes’s works started losing fame in the 1970s when his opponents raised doubts about his contributions. However, after the financial crisis of 2007-2009, his work gained recognition again when governments started applying his theories to help them recover from the predicament. Keynes married Lopokova in 1925, but they did not have children until when he died later in 1946 (Eatwell and Milgate 50). Keynes’s Contribution to Economics Theory of Employment John Keynes argues that the level of employment is dependent on the level of demand in an economy. According to his theory, effective demand is the main driver of an economy because it also determines the level of output in a country (Keynes 37). The effective demand in the economy is made up of two factors that include investment and consumption. This is because Keynes postulates that individuals use the income that they earn for consumption and savings. The income that is saved is then used to undertake various investment projects. In his view, Keynes argued that an increase in the level of effective demand in an economy leads to an increase in the level of employment (Forstater 46). This is because organizations will require additional workers who will help in producing the extra output that satisfies demand. However, when the level of effective demand decreases, companies lay off workers because they require few workers to produce the decreased output. The economist came up with formulae that determine consumption and investment values. Keynes believed that the proportion of income that is not saved is the primary determinant of consumption level. This proportion is adjustable and it is known as the Marginal Propensity to Consume (MPC). The magnitude of investment, on the other hand, is determined by the Marginal Propensity to Invest (MPI). The MPC is the rate at which consumption changes when the level of income varies. Keynes argued that the propensity to consume is less than unity because he believed that while consumption increases when income increases, the increase is usually less than that of income (Eatwell and Milgate 54). The theory of employment also argues that the proportion of savings is equal to unity minus MPC (1-mpc). It is through the tendency to save that Keynes came up with the investment multiplier, which determines the change in investment that arises when income varies. According to Keynes, the investment multiplier is found by the formula 1/ (1-mpc) (Coddington 62). Keynes argues that the value of the investment multiplier indicates that effective demand increases with a high magnitude when investment changes by a miniature amount. The factor also indicates that when the propensity to save is high, it leads to low investments but, when it is low, it leads to high investments. The increase in effective demand that results from the multiplier then causes an increase in the level of employment in an economy (Keynes 73). Therefore, Maynard concluded that when the propensity to invest is low compared to the propensity to save in an economy, this leads to prolonged depression periods that may not be corrected by any natural forces. This conclusion opposes the view of classical economists who argue that natural forces act towards leading an economy into its full employment level (Forstater 57). The Theory of Interest Keynes argued that the level of interest rate in an economy depends on the demand and supply for liquidity. The individuals involved in the demand and supply for liquidity are the wealth holders who lend their money at a rate. Keynes argued that the interest rate at which wealth holders lend their money depends on their future expectations (Keynes 84). When the lenders are uncertain about the future while lending money, they charge a high interest rate on the borrowers. However, when lenders are optimistic about the future, they charge low interest rates on their money (Coddington 70). This means that when the future is uncertain, money lenders prefer to hold their money in cash rather than to lend it to borrowers. According to John Keynes, when lenders are uncertain about the future, their expectations of earning profits on investments decrease (95). This causes them to charge a high interest rate on the funds that they lend out to borrowers. The consequent effect of this action is that it leads to an overall decline in investments in an economy. The decline in the value of investment then leads to a decline in the level of effective demand, output, and employment (Keynes, Johnson and Moggridge 82). When wealth holders are optimistic, on the other hand, they expect their profits to increase. This triggers them to lend out their funds to borrowers who use the money to invest in various projects that produce high returns. This move causes the amount of investment to increase in the economy, which in turn increases the amount of effective demand. The increase in the amount of effective demand then causes an increase in total output and employment (Keynes, Johnson and Moggridge 86). Keynes, however, argues that the demand and supply for liquidity may be unsuccessful in changing the level of interest rate in an economy when expectations of the future are low. In this case, the theorist argued that the Central Bank should intervene through the monetary policy (Keynes 102). The Central Bank’s intervention would aim at decreasing the liquidity in the economy by setting interest rates at low levels. The low interest rates would then raise investment, which would in turn increase effective demand, employment, and output. This view of Keynes opposes the classical economist’s argument that natural forces of demand and supply act towards achieving an interest rate that equates savings and investments in an economy. The classical theorists did not believe in intervention through the monetary policy because they argued that this would lead to an additional disequilibrium in the economy (Eatwell and Milgate 91). Theory of Wages John Keynes argues that a decrease in wages in an economy leads to a prolonged period of recession because the outcome of this is worse. Keynes postulates that when employers decrease the wages that they pay their workers, this leads to the reduction of prices (Eatwell and Milgate 96). The reduction of prices then decreases the profits that businesses earn and this leads to a further reduction of wages. Keynes, however, argued that there is a tendency of wages to be rigid in the economy because workers would not consent to a wage cut. This argument indicates that Keynes supported minimum wages and labour unions in the economy. Although Keynes argues that a reduction in wages leads to a decrease in prices, he postulates that in an economy with fixed foreign exchange rate, prices of exports may remain constant when wages shrink (Keynes, Johnson and Moggridge 118). Quantity Theory of Money The quantity theory of money was first developed by the classical economists who argued that an increase or a decrease in effective demand does not have any effect on price. Keynes opposed this argument by postulating that an increase in demand leads to a consequent rise in the level of prices; while a fall in demand causes a reduction in prices (Coddington 135). The economist also argued that there is no need for money supply because it does not have an effect on prices. According to Keynes, increases in the level of money supply leads to a downward pressure on interest rates while decreases in money supply leads to an increase in the interest rates (144). The decrease in interest rates then boosts the productivity of firms leading to additional employment in the economy. Therefore, Keynes’s quantity theory of money assumes that any variation in money supply affects interest rate while a variation in effective demand causes changes in prices in an economy. Mixed Economy Keynes proposed that the government should intervene in an economy by using its fiscal and monetary policies. The economist proposed this because he believes that the economy cannot attain equilibrium if it is left on its own because of the existence of inefficiencies. Keynes argues that the state intervention though fiscal policy take place through taxation and government spending. Monetary policy, on the other hand, is in the form of bank rate and open market operations (Keynes 160). This proposition of Keynes is opposed to the view of classical economist’s argument that the economy achieves equilibrium on its own through natural forces. Impact of Keynes’s contributions on Economic Theory Keynes’s contributions to economics have had a significant impact on economic theory through the Keynesian economics. The major impact of Keynes’s theory of demand is that it is used as the basis of calculating the level of national income in economic theory (Eatwell and Milgate 97). This has also been practical because public policy makers use the national income formulas that are based on Keynes’s theory to compute Gross Domestic Product. For example, Britain calculated its national income after the Second World War based on the Keynesian Theory of Income. Maynard’s theory of interest is also used widely in economic theory to determine the level at which an economy achieves full employment. In addition to this, the theory of rigid wages is also applicable in economic theory. This theory has also gained support from other economists such as the classical economists who also argue that wages are rigid downwards while they are flexible upwards (Forstater 108). Keynes’s theory of interest is also applicable in economic theory although it has gained opposition from modern and traditional economics. The opponents of the theory argue that interest rate is determined by the demand and supply for savings. This opposition has caused the theory of interest by Keynes to deteriorate in terms of application in economic theory (Eatwell and Milgate 123). Keynes proposition of government intervention has led to the study of fiscal and monetary policies in economic theory. The policies are also practical in nature because almost every government in the world uses taxation and spending to stimulate the economy to achieve certain objectives. The monetary policy is also applicable and it is practiced by Central Banks through open market operations, bank rates, and bank reserves (Coddington 164). Conclusion John Maynard Keynes is an economist who was born in Cambridge in 1883. Keynes studied mathematics and economics in Cambridge College under the guidance of Alfred Marshall. Keynes’s father was an author and a friend of Marshall. John Keynes began his career after school when he was employed at the Indian Treasury. Keynes’s contributions to economics include the theory of employment, theory of wages, interest rate hypothesis, quantity theory of money, and proposition of an interventionist economy. In the theory of employment, Keynes argues that effective demand is responsible for the variations of the level of employment. According to Maynard, an increase in effective demand causes an increase in output and employment. A decrease in effective demand, on the other hand, causes a decrease in total output and income. In his theory of interest, Keynes argues that the rate of interest is determined by the variations in the demand for liquidity, which depends on future expectations. Keynes’s contributions to economics are applicable in economic theory. For example, in economic theory, the calculation of national income statistics is based on John’s arguments. However, Keynes’s argument of calculating interest rate has been rejected by traditional economists who believe that the rate is determined by the supply and demand for savings in an economy. Overall, Keynes’s contributions have been accepted both in economic theory and practically. Works Cited Keynes, John M, Elizabeth Johnson, and D E. Moggridge. The Collected Writings of John Maynard Keynes: Volume 1 : Indian Currency and Finance. Cambridge: Cambridge University Press, 2013. Print. Keynes, John M. The General Theory of Employment, Interest and Money. Cambridge: Cambridge University Press, 2013. Print. Coddington, Alan. Keynesian Economics. Hoboken: Taylor and Francis, 2013. Internet resource Eatwell, John, and Murray Milgate. The Fall and Rise of Keynesian Economics. New York: Oxford University Press, 2011. Print. Forstater, Mathew. Economics. Chicago: Chicago Review Press, 2007. Print. Read More