Question

Explain how Keynes in his General Theory of Employment, Interest and Money, connects the what happens in the monetary economy to the real economy to explain how a capitalist economy can end up in a state of unemployment in equilibrium. How did this lead him to the policy prescriptions he proposed to bring capitalist economies out of the Great Depression? Try to be detailed

Answer 1

Monetarists believe that during recession wen Aggregate demand has shifted to left as shown below then wages will go down and also other factor prices.This will make supplier to supply more and hence equilibrium which had shifted from a to b will shift back at LRAS(Long run aggregate supply ) curve at point c.

This shows how economy achives its potential Yp in the long run. Hence no govt. intervention needed.

However, Keynes believes that prices will not go from a to b but as shown in fig. below, it will be stuck at b and real GDP will be stuck at Y2. Jobs will be lost. This happens as wages are sticky and factor prices cannot easily go down.

Hence as economy is stuck it needs govt. intervention in the market to generate jobs and bring back economy at normalcy(Y1).

Hence Keynes suggested govt. to increase govt. investments so that aggregate demand is shifted to right, people get jobs. Increase disposable income and this leads to further more spending which will help in restoration of potential output.