Question

What are the contributions of "The general theory of employment, interest and money" by Keynes?

Answer 1

Keynes wrote the book "The general theory of employment, interest and money" in 1936 which opened up new dimensions for the economy to respond in situations like depression. The book critically argued the Traditional Classical Theory who believes in Laissez-Faire System.

Keynes major development was that in order to revive the economy the best way is to run the deficit spending. Government must intervene to re-store the equilibrium.

Following are the major contributions:

- Expaliained Consumption Function in depths: Keynes examined the consumption function in more depth and considered a major factor in the development of the economy. He talked about the disposable income and the marginal propensity to consumer as the drivers of household consumption. Disposable income is then sub-divided into Actual income, Taxes and Transfers made by the government.

- Examination of Investment Function: He put-forth that investment depends upon the Marginal Efficiency of Capital And the interest rate. Marginal Efficiency of Capital in-turn depends upon the prospective yield, replacement cost of capital. On the other hand, the interest depends upon the quantity of money in the economy.

- Invention of Liquidity Preference Theory: Keynes, under this theory, conculed that the demand for money has three main purposes: Speculative Motive of money demand, Precautionary motive of money demand, Transactionary Motive of the money demand. He explained special cases like Liquidity Trap in this theory.

- Suggested changes in Fiscal and Monetary Policy Response: he was of the opinion that in situations like depression, the government should intervene and adopt expansionary fiscal policy to stimulate the economy. So, he completely break the classical ideas of no government intervention and puts more emphasis on the demand side of the economy.