Question

What is the significance of the title The General Theory of Employment, Interest and Money, by J.M. Keynes? (Hint: focus on the works "General Theory")

In the General TheoryKeynes attacks the main postulates of the Classical School. What were these postulates and how did he attack them?

Answer 1

In the book "The General Theory of Employment, Interest and Money", Keynes focuses on employment being determined by the Aggregate Demand and Aggregate Supply and it denies the Say's Law of supply creating it's own demand. If at the full employment level, the demand is below the level of output, the economy must function such that the equilibrium is achieved. This book talks in detail of the Great Depression of 1930s and has suggested solutions to the problems faced during the same.

J.M. Keynes believed that the postulates of the Classical School are applicable only to special cases and not general cases. Following are the postulates criticized by Keynes:

1. Classical assumption of Full Employment: He considered it to be unrealistic and believed in the existence of underemployment in a Capital Economy.

2. Refuted Say's Law of Supply creating it's own demand: Keynes pointed out that, out of the total money earned only a part will be spent and the rest will be saved by households.

3. Equality of Savings and Investment: The classical school believed that at full employment, the savings and investment are equal and if there are any distortions, the savings and investment would be equalised through the mechanism of rate of interest. However, Keynes was of the opinion that the investment is determined by both interest rate and Marginal Efficiency of Capital. Also, the level of savings will depend on the income and not the interest rate.

4. Speculative demand for money: The Classical school only believed in money being used for transactionary and precautionary purposes. Keynes also mentioned about the importance of speculative demand for money.

5. Rejection of Quantity Theory of Money: Keynes rejected the Quantity theory of money as an increase in money supply does not always lead to an increase in price.

6. No direct and proportional relationship between money and real wages: Keynes believed that there existed an inverse relationship between money and real wages.

7. State intervention: Keynes believed that state intervention is necessary for the proper functioning of the society.

8. Unrealistic long run analysis: Keynes philosophy was a short run philosophy as he believed that in the long run all will be dead.