Unlike last week's lecture about reference and sense, economics has no point of reference and ignores need. Money is for enjoyment; we do not need things, we simply want them and we judge to maximise our utilities, we make deals for the same purpose and what we will do to get money depends on the individual, this is otherwise known as utilitarianism. Richardo had the the labour theory of value; he believed that value was dependent on labour; things with greater labour cost more. Malthus had the iron law of population; when he was writing there was an exponential growth in population.
Marx however believed in the iron law of wages; over production and under consumption; if lots of people want to do a job then the wages go down, and if no one wants to do a job then the wages go up, he believed that this was a recurring problem. He felt that something was worth what people would pay for it, if people cant afford to buy something then its value goes down, wages are cut and the apple is cheaper but people still cant afford it; this is deflation.
Expansion of paper money has led to money being described as transparent by Alfred Marshall as it is no longer based on gold supply, with modern economics the state must intervene; money is printed to pay for things such as state welfare, education and the army and is no longer based on gold. The economy and government debt don't have to expand at the same rate, this reduces unemployment and keeps people employed. Printing money not backed by gold does however cause the problem of inflation.
Followers of Adam Smith would say that they believe everyone calculates what they want through the market and that people make accurate decisions based on the economy but this was criticized by followers of Keynes who felt that they didn't care about inflation; it is nominal and irrelevant. They feel that the economy must be planed to reduce unemployment with projects to reduce unemployment, good ways of spending money are on things such as hospitals and the space program.
This Keynesian way of thinking was adopted from the thinking of Keynes and his General theory of employment interest and money. Keynes is one of the most influential economists and his work and ideas have shaped the economy today. The general theory was a call for big government and high taxes. The book was at first seen to have 'evil' ideas but this campaign eventually collapsed. Keynes wanted to save capitalism; he wrote during a time of mass unemployment, waste and suffering with many declaring capitalism a failure. Keynes however felt that he had found a small technical cause that had a small technical solution, Keynes felt that less government intervention was key.
The general theory is composed of four points:
1. Economics can suffer from an overall lack of demand which leads to involuntary unemployment.
2. The economy's automatic tendency to correct shortfalls in demand operates slowly and painfully.
3.Government policies to increase demand can reduce unemployment quickly.
4.Sometimes increasing the money supply wont be enough to persuade the private sector to spedn more and government spending must step into the breach.
These views were seen as radical ideas when Keynes proposed them but they are accepted now, showing his influence on economics.
Keynes began to re-think economic and was so successful in this, many of his radical ideas are now accepted as obvious. Book 1 was Keynes manifesto and was written for knowledgeable insiders. He managed to show that the conventional view of wages and employment made no sense; cutting wages to get full employment did not work, while suggesting that the great depression was easily solvable. He writes of Malthus in this book and how he said that failures in demand were possible but had no model to back up his ideas. He believed that an alternative construction was needed to create the detail needed to clarify our thoughts and explain them to others. Detail needed to be precise as he was challenging a long established orthodoxy. He understood the power of the reigning orthodoxy and therefore his pace is slow and step by step.
Keynes tried to liberate people from 'classical economics'. It was hard for Keynes to escape from classical economics than it would be for us, as his ideas are now incorporated into modern economics. The classical model was hard to Keynes to fix. Ideas we take for granted now were seen as impossible. In the core of the book, he challenges economic orthodoxy, offering clear, coherent and carefully reasoned ideas in order to change peoples minds.
In book V Keynes confronts the naive idea that a fall in ages can increase employment. He demolished Say's law and the classical theory of interest rates in book IV. Keynes derived his answers from economics that we now take for granted, and these were seen as unthinkable. Keynes also had to break away from the business cycle theory of the day.
Most macroeconomic theorists at the time before Keynes were answering the wrong questions; they were trying to explain why booms are followed by busts rather than why unemployment is even possible. But Keynes felt that he should try to explain why the economy sometimes operates below full employment. How can we create more employment was the question that Keynes answered. It freed Keynes from the false notion of the business cycle as a morality play of an economic slump as a necessary after a boom. Keynes analysed how the economy became depressed in the first place.
The general theory transformed the way that everyone thought about the economy. Are we all Keynesians now? Keynes also discussed how changes in the quantity of money can affect interest rates and aggregate demand, therefore not ignoring monetary policy. The general theory does contain scepticism about whether adding to the money supply is enough to restore full employment. When it was written, the economy interest rates were so low that there was little point increasing money supply could do to push them lower. Keynes felt that monetary policy had worked in the past but not now. Keynes did however believe that the conditions of the 1930's would persist indefinitely.
Keynes did miss some things in his theory however. He mistook an episode for a trend. He believed wrongly that monetary environment of the 1930s would be the norm from then on. He underestimated the ability of mature economies to stave off diminishing returns. He also believed that the euthanasia of the rentier was predicted on the presumption that as capital accumulates, profitable private investments become hard to find, so that marginal efficiency of capital declines. The euthanasia of the rentier does not seem immanent but may have seemed reasonable at the time. Keynes did not see a future of persistent inflation. and was therefore pessimistic about future monetary policy and never addressed problems relating to this.
Keynes has been described as a saviour of the economy, he was an intellectual insider who understood the prevailing economic ideas of his day as we as anyone. He was a radical who challenged the ideas he had been taught. He transformed our perception of the world and made the ideas that mass unemployment was a result of inadequate demand obvious. Keynes turned unemployment from being regarded as a problem with complex causes into a simple answer with simple causes. Inadequate demand demand had a simple solution; expansionary fiscal policy.
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