I looked at this before and got lost in it as I recall. Found a quote in chapter six of The General Theory:
Furthermore, the effective demand is simply the aggregate income (or proceeds) which the entrepreneurs expect to receive, inclusive of the incomes which they will hand on to other factors of production, from the amount of current employment which they decide to give.
First of all, it depends on entrepreneurs' expectations, which drive them to spend the money to produce the product that, when sold, will generate the income.
Second, the expected income includes the portion of that income which the entrepreneurs will have to fork over to other entrepreneurs. Since that portion is included, and as we are not doing calculations here, I'm going to omit the part about portions of income.
Effective demand is the income entrepreneurs expect to receive from the amount of current employment which they decide to give.
Effective demand is expected income, then. It is the particular expected income that leads to employment.
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Effective demand is the demand I expect to see, demand as measured by income, income I get from selling my product, expected income from the employment of N workers.
So the word "effective" refers to what, exactly?
Something has an effect, and something is the effect.
The proposed employment of N men has an expected effect on income. This leads the employer to pick a best-case N. Employment follows. Output and income is generated. Done.
So we have an employer thinking about hiring some guys, as the cause of everything that follows.
Or we have employment as the cause of income. Oh -- but that is Say's law.
Okay. Either way, this is not at all what I thought "effective demand" means. And it's not at all what Adam Smith meant by "effectual demand". I'm sure of that.
Looks like I'm lost again.
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I did find something in part two of A multi-sectoral version of the Post-Keynesian growth model (PDF, 26 pages) by Ricardo Azevedo Araujo and JoanÃlio Rodolpho Teixeira:
Unlike the Neoclassical model, the PKGM considers that neither savings nor technological progress is the variable that drives the growth process. The rationale is that investment is determined essentially by the availability of credit in the financial sector as well as the ‘animal spirits’. Once investment is made effective demand determines output which in turns determines savings.
With a comma? Like this:
Once investment is made, effective demand determines output which in turns determines savings.
Here, the employer goes with his gut, giving N workers employment, whereupon demand is generated -- demand, measured by income -- and yadda yadda savings.
It's the decision to employ N workers that has the effect. I guess that's what Keynes was saying. But again, Say's law follows.
Or maybe the comma goes like this:
Once investment is made effective, demand determines output which in turns determines savings.
And then I got nothin'.
3 comments:
Here, the employer goes with his gut, giving N workers employment, whereupon demand is generated -- demand, measured by income -- and yadda yadda savings. It's the decision to employ N workers that has the effect. I guess that's what Keynes was saying. But again, Say's law follows."
The way I understand it, Say's law doesn't follow because liquidity preference where a portion of income is retained as money balances (yadda yadda savings) is a leakage from demand leading to conditions where the demand effects of investment are insufficient to absorb the supply effects of investment (paraphrasing, or maybe mangling, Wray on Keynes here).
What Keynes means in a nutshell is that effective demand is that which brings forth investment that funds income. It is just the circular flow of money involved in the production-distribution-cycle. Simplifying, it is the amount that consumers will have to spend on product based on what they make. It is essentially Say's law at full employment and if consumers (workers and owners consumption) spend everything they make then everything available for sale at full employment of available resource will take place and the economy will be in equilibrium. This is just an accounting identify involving flows.
Keynes is OK with this analysis in a non-monetary production (barter) economy. This was in fact Alfred Marshall's model to which he was responding. As I understand it, Keynes was a mathematician and not widely read in economics. Alfred Marshall was the dominant figure at the time and Keynes was responding to Marshall's neoclassical model based on marginalism.although the principle is classical. Keynes says he is aiming at the errors in the "classical" theory.
But in a monetary production economy involving credit and saving, liquidity preference changes based on animal spirits. This means that there can be demand leakage to savings that means not everything that can be produced at full use of resources will find a buyer.
Moreover, drawing income forward through credit can create more demand than supply at full use of available resources, where quantity cannot expand to meet increased demand. The classicals knew this and their equilibrium was only an ideal. They knew that economies only approximate equilibrium. They held, however, that a general glut could not persist in the long run because free markets would correct.
Keynes didn't disagree with this view in essence but in practice. As he said, "In the long run we are all dead." Why wait for markets to correct or endure the disadvantages unnecessarily when it is possible to adjust effective demand by broadening investment to include the government sector.
In case of anticipated or actual deficiency in demand, another sector will have to restore balance by running a deficit or a surplus as the case may be. Government is able to do this. Keynes also recommended using monetary policy to affect liquidity preference through the interest rate.
Austrians generally agree with this analysis, but hold that this doesn't purge the economy of malinvestment, so it is not a useful policy.
Neoclassical economists don't disagree either, or at least many don't since the analysis is based on accounting identities. But they prefer monetary policy for a variety of reasons, some of which have been shown to be erroneous theoretically and others ineffective. They believe that fiscal policy should either be avoided or minimized as too political.
Then there are the free market ideologues.
I should also say that Keynes as a firm believer in the role of expectations and confidence in expectations like other economists.
Effective demand is about expectations for future activity based on conditions.
Where Keynes differs in in uncertainty and animal spirits. This means that the conventional view of expectations and confidence based on rationality is misplaced so that the deviation from equilibrium at full resource use can be more variable and of longer duration than conventional economists assume. Keynes also held that an economy can experience equilibrium at less than full employment of available resources.
Government has the power to maintain high confidence in positive expectations through managed policy rather than reliance on market forces alone.
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