The General Theory of Employment, Interest, and Money (Great Minds) | John Maynard Keynes

Summary of: The General Theory of Employment, Interest, and Money (Great Minds)
By: John Maynard Keynes

Introduction

Dive into the intriguing findings of John Maynard Keynes’ groundbreaking ‘The General Theory’ where he offers a revolutionary framework for understanding economic crises and ways to overcome them. Rejecting the idea of ‘laissez-faire capitalism,’ Keynes challenges the classical economic models and their assumptions. In his general theory, he puts forth the concepts of aggregate demand, effective demand, and the importance of money as a connector between the present and future, adding nuance to the understanding of how economies function. This summary will guide you through Keynes’ ideas on liquidity preference, interest rates, consumption, investment, as well as the dependent and independent variables of a functional economy, ultimately offering insights into how governments can bring stability and induce progress.

The Failure of Classical Economics

The Great Depression exposed the flaws of laissez-faire capitalism and the inadequacy of classical economics. The book argues for a new “general theory” that can explain the behavior of the entire economic system during crises and downturns. Unregulated capitalism does not efficiently return an economy to maximum resource utilization after shocks. The book provides insights into changing output and employment levels and calls for a new economic approach that considers the system as a whole.

Aggregate Demand and Classical Model

The concept of Aggregate Demand in economics states that an increase in supply creates its own demand. According to classical theory, aggregate demand represents the proceeds entrepreneurs expect from employing ‘N’ men, while the price of employing ‘N’ men denotes aggregate supply. Effective demand is the point where demand and supply meet, representing the maximum employer profits and level of full employment. However, investments are sensitive to future expectations, which can lead to quick and damaging swings in activity and capital costs. Such changes affect the prices of wages and goods, leading to involuntary unemployment, as witnessed in the US during the Great Depression. The book emphasizes that the ideas of economists and political philosophers have a significant impact on the world, and their perspectives are capable of influencing the level of employment in the economy.

The Role of Money in Free Markets

In a free market, supply and demand balance the resources used in producing and distributing goods and services, while money serves as a unit of exchange without an active role. Classical economics theory holds that savings become “enterprise investment,” but money matters because it serves as a link between the present and the future. Money is not only a unit of exchange, but it also serves as a “store of wealth,” allowing individuals to form a “liquidity preference.” This preference changes with circumstances. During uncertain times, individuals and organizations prefer liquidity – holding cash or liquid assets that can easily turn into cash. This reveals that money is not just a means of exchange but an important tool for future planning.

Understanding Interest Rates

In this summary, we explore the relationship between interest rates, consumption, and liquidity. We’ll look at the assumptions of the classical analysis, the effects of income changes on consumption preferences, and the impact of hoarding on interest rates. Finally, we’ll touch on changes in money supply and how they affect interest rates.

To attract investors, an enterprise must offer a rate of return that exceeds the interest rate, which is the price that creates equilibrium between the desire to hold cash and the available quantity of cash. However, the interest rate is not the price of savers’ readiness to abstain from present consumption, as the classical analysis assumes.

Under normal circumstances, individuals tend to maintain a stable propensity to consume a certain portion of their income, but substantial shifts in fortunes may influence their consumption preferences. Beyond consumption and liquidity levels, people typically want to invest increased income.

In the real world, the riskier the economic climate appears, the more people tend to hoard cash, and enterprises will have to pay reluctant savers to give up liquidity, pushing up interest rates to achieve equilibrium between the demand for holding cash and the money supply.

Changes in money supply affect interest rates. The Quantity Theory of Money says increased money availability increases jobs to a level of full employment, at which time the general price level rises in relation to the amount of money in circulation, leading to inflation. Typically, interest rates fall when the quantity of money increases.

In conclusion, while the classical theory assumes certain characteristics for economic society that may not be true, in the real world, interest rates play a crucial role in balancing liquidity and investments. Changes in factors such as money supply, consumption preferences, and economic climate can significantly impact interest rates.

Demystifying Capital Investment

Entrepreneurs invest in durable assets to create salable outputs, with the expected revenue streams being the returns on investment. The prospective yields of investments are essentially a series of annuities, and the return on investment is calculated by subtracting output costs from sales proceeds. The replacement cost of output units determines their supply price, which is what a businessperson will accept to create additional product units. The marginal efficiency of capital is a crucial factor in determining the value of a capital asset, as it adds to the prospective yield. It is calculated by estimating the costs of the annuities’ present value, which in turn would equal the supply price. Capital assets constitute all present investment opportunities, and the investment-demand schedule is also referred to as the schedule of the marginal efficiency of capital.

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