Posted by: Dirk | December 21, 2015

Why is the “General Theory” a “general” theory?

The answer to the above question is found in the book’s chapters one and two (source):

I have called this book the General Theory of Employment, Interest and Money, placing the emphasis on the prefix general. The object of such a title is to contrast the character of my arguments and conclusions with those of the classical [1] theory of the subject, upon which I was brought up and which dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past. I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.

[…]

The classical theory of employment¾supposedly simple and obvious¾has been based, I think, on two fundamental postulates, though practically without discussion, namely:

I. The wage is equal to the marginal product of labour

That is to say, the wage of an employed person is equal to the value which would be lost if employment were to be reduced by one unit (after deducting any other costs which this reduction of output would avoid); subject, however, to the qualification that the equality may be disturbed, in accordance with certain principles, if competition and markets are imperfect.

II. The utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment.

That is to say, the real wage of an employed person is that which is just sufficient (in the estimation of the employed persons themselves) to induce the volume of labour actually employed to be forthcoming; subject to the qualification that the equality for each individual unit of labour may be disturbed by combination between employable units analogous to the imperfections [p.6] of competition which qualify the first postulate. Disutility must be here understood to cover every kind of reason which might lead a man, or a body of men, to withhold their labour rather than accept a wage which had to them a utility below a certain minimum.

[..]

Let us assume, for the moment, that labour is not prepared to work for a lower money-wage and that a reduction in the existing level of money-wages would lead, through strikes or otherwise, to a withdrawal from the labour market of labour which is now employed. Does it follow from this that the existing level of real wages accurately measures the marginal disutility of labour? Not necessarily. For, although a reduction in the existing money-wage would lead to a withdrawal of labour, it does not follow that a fall in the value of the existing money-wage in terms of wage-goods would do so, if it were due to a rise in the price of the latter. In other words, it may be the case that within a certain range the demand of labour is for a minimum money-wage and not for a minimum real wage. The classical school have (sic!) tacitly assumed that this would involve no significant change in their theory. But this is not so. For if the supply of labour is not a function of real wages as its sole variable, their argument breaks down entirely and leaves the question of what the actual employment will be quite indeterminate.[1]  They do not seem to have realised that, unless the supply of labour is a function of real wages alone, [p.9] their supply curve for labour will shift bodily with every movement of prices. Thus their method is tied up with their very special assumptions, and cannot be adapted to deal with the more general case.

With hindsight, it seems to me that Keynes was arguing against the classics, but he did not go further. With indebted workers, there must be wage levels which are consistent with repayment of loans and others which are not. Also, wage levels depend on demand for labor, and this Keynes makes clear later in the book.

So, the way I read it the General Theory includes the special case of workers being paid their marginal product of labour. Nevertheless, even in this special case depression can and will arise if aggregate demand for some reason falls sharply.


Responses

  1. […] have recently commented on why the General Theory by Keynes (1936) is a general theory. Reading chapter 3, I might change […]


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