Transcript Keynes on Consumption, Saving, and Investment

Alfred Marshall
Principles of Economics (1890)
vs
John Maynard Keynes
The General Theory (1936)
ALFRED MARSHALL
JOHN M. KEYNES
Mr. Supply & Demand Mr. Income-Expenditure
For a wholly private economy……………..…………….
Marshall
Keynes
Does “equilibrium” entail an
equality between S and I?
YES
YES
Is there a market process that
results in that equality?
YES
YES
How does a market economy
make the adjustment?
Interest rate
Is the adjustment consistent
with prosperity?
YES
What should the government
do about it?
Nothing
(Laissez Faire)
Income
Doubt it.
Manipulate
It’s not just that S = -a + (1 – b)Y,
It’s that S = -a + (1 – b)Y, PERIOD!!!
S doesn’t depend on the rate of interest.
And I doesn’t depend on the interest rate either!
Y=E
S = -a + (1-b)Y
S=I
I = Io
“Loanable funds” is the generic term that refers to both lending
(which constitutes the supply side of the market) and borrowing
(which constitutes the demand side).
Each side of the market for loanable funds is governed by the rate
of interest.
Saving, broadly conceived, underlies the supply of loanable funds.
The Market for Loanable Funds
“Loanable funds” is the generic term that refers to both lending
(which constitutes the supply side of the market) and borrowing
(which constitutes the demand side).
Each side of the market for loanable funds is governed by the rate
of interest.
Saving, broadly conceived, underlies the supply of loanable funds.
Borrowing by the business community constitutes the demand.
The Market for Loanable Funds
“Loanable funds” is the generic term that refers to both lending
(which constitutes the supply side of the market) and borrowing
(which constitutes the demand side).
Each side of the market for loanable funds is governed by the rate
of interest.
Saving, broadly conceived, underlies the supply of loanable funds.
Borrowing by the business community constitutes the demand.
The quantity
This
market isaxis
better
measures
thought
of as the
saving
(and
market
investment)
for
as
investable
the
amountresources.
of output It
keeps the in
produced
macroeconomically
a given period
relevant
and
madeconcepts
available
offor
saving
(and
(S) and investment
actually
used for) the
(I) in
balance. of the economy’s
expansion
productive capacity.
S=I
The Market for Loanable Funds
Suppose that people become more
thrifty; they choose to save more.
Suppose that people become more
thrifty; they choose to save more.
Suppose that people become more
thrifty; they choose to save more.
-a’
-a
Suppose that people become more
thrifty; they choose to save more.
-a’
-a
Suppose that people become more
thrifty; they choose to save more.
“Every ... attempt to save
more by reducing
consumption will so affect
incomes that the attempt
necessarily defeats itself.”
--from The General Theory, 1936.
In other words, by trying to
increase your saving out of a
given income, you will only
decrease your income and
The market at
struggle to save as much as
you saved
workbefore.
for you
and for me.
This is Keynes’s “Paradox of Thrift.
-a’
-a
The market at
work to the
detriment of
us all.
The General Theory
of Employment, Interest, and Money
John Maynard Keynes
1936
John Maynard Keynes
on
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.”
John Maynard Keynes, The General Theory, 1936, p. 96.
...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.
C = a + bY, where “b” is less than 1
If income (Y) increases by Y, then
consumption (C) increases by bY.
For b = 0.75, if income increases by 200,
consumption increases by 150.
John Maynard Keynes
on
Saving
“The influence of [the interest rate] on
the rate of spending [and hence on the
rate of saving] out of a given income is
open to a good deal of doubt.”
John Maynard Keynes, The General Theory, 1936, p. 93.
“It has long been recognized … that the
total effect of changes in the rate of
interest on the readiness to spend on
present consumption is complex and
uncertain, being dependent on conflicting
tendencies, since some of the subjective
motives towards saving will be more
easily satisfied if the rate of interest
rises, whilst others will be weakened.”
John Maynard Keynes, The General Theory, 1936, p. 93.
“There are not many people who will alter
their way of living because the rate of
interest has fallen from 5 to 4 percent....”
“[T]he main conclusion suggested by
experience is, I think, that the short-period
influence of the rate of interest on
individual spending [and hence on
individual saving] out of a given income is
secondary and relatively unimportant…”
John Maynard Keynes, The General Theory, 1936, p. 94.
What Keynes might well have written:
Though not responsive to changes in the
interest rate, men are disposed, as a rule
and on the average, to increase their saving
as their income increases, but not by as
much as the increase in their income.
In other words, when people earn more,
they spend more and they save more.
...men are disposed, as a rule and on the
average, to increase their saving as their
income increases, but not by as much as
the increase in their income.
S = -a + (1 - b)Y, where “b” is less than 1
If income (Y) increases by Y,
then saving (S) increases by (1 - b)Y.
For b = 0.75 (and hence 1 - b = 0.25),
if Y increases by 200, S increases by 50.
[When their incomes fall temporarily to
zero]...men are disposed, as a rule and on
the average, to do some spending (a) out of
accumulated savings, which means that
they dissave (-a) by that same amount.
C = a + bY, where “a” is greater than 0
S = -a + (1 - b)Y, where “-a” is less than 0
When income is temporarily zero, then
consumption is “a” and (dis)saving is “-a.”
John Maynard Keynes
on
Investment
“Most, probably, of our decisions to do
something positive, the full consequences
of which will be drawn out over many days
to come, can only be taken as a result of
animal spirits ---of a spontaneous urge to
action rather than inaction, and not as an
outcome of [economic calculation].”
John Maynard Keynes, The General Theory, 1936, p. 161.
“Only a little more than an expedition to the
South Pole is [investment] based on exact
benefits to come. Thus if the animal spirits
are dimmed and spontaneous optimism
falters, leaving us to depend upon nothing
but a mathematical expectation, enterprise
will fade and die;--though fears of loss may
have a basis no more reasonable than
hopes of profit had before.”
John Maynard Keynes, The General Theory, 1936, p. 162.
“[I]ndividual initiative will be adequate
when reasonable calculation is
supplemented and supported by
animal spirits, so that the thought of
ultimate loss which often overtakes
pioneers, as experience ultimately tells
us and them, is put aside as a healthy
man puts aside the expectation of
death.”
John Maynard Keynes, The General Theory, 1936, p.
162.
So, we have it from Keynes that
C is based solely on Y.
S is what’s left over; it’s a residual.
I is determined by “animal spirits.”
Where do we go from here?
The General Theory
of Employment, Interest, and Money
John Maynard Keynes
1936