Question

How did Hansen and Hicks change Keynesian economics?

Answer 1

J. R. Hicks and Alvin Hansen together gave a theory of interest rate which proved that both the theory of classical and Keynesian are incomplete and indeterminate in their form. The theory known as Hicks-Hansen theory of interest combined the theory of classical and Keynes to make up a complete and determinant theory of interest.

The classical theory considers savings to be equal to the interest rate that is as an interest rate (i) rises the saving also rises. That is:

s = s(r) where s'> 0

i = i(r) where i'<0

We know at equilibrium; s(r) = i(r). So in classical theory, it is assumed that saving is the function of the rate of interest only.

Keynes incorporated the income concept in this. He said that saving is not the only function of interest rate but also the function of Income. So as income increases the saving also increases. According to Keynes:

s = s(r,y), ?s/?r > 0, ?s/?y > 0

Hicks and Hansen further extended the theory of Keynes saying that saving is not just a function of income but it is family of s curve. So the above equation is the family of s curve.

According to HIcks and Hansen, the s(r) is a function of y. So for each income (y), there is different s(r) hence it is actually a family of saving (s) curve.