Abstract
This paper reviews several models for teaching Keynes’s principle of effective demand with a special focus on a framework that is familiar to advanced undergraduate students of macroeconomics: the real wage vs. employment space. It is argued that existing approaches to teaching Keynes’s principle of effective demand reflect a tension between two goals: being true to Keynes and translating the effective-demand principle into a story about real wages and employment within a single graphical space. Our main contribution consists of presenting an extended version of a model originally proposed by Lavoie (Rev Radic Polit Econ, 35(2):166–182, 2003), which seems to be a reasonable compromise between these two goals.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
By new-Keynesian, we mean the model based on the intersection between the so-called price-setting equation and the wage-setting curve. This model is briefly discussed in “An Extension of the Lavoie’s Model”.
“It is difficult to read the General Theory without experiencing a disconnect between what is in the book and what one has learned about Keynesian economics as a student. The most egregious misrepresentation is the notion of aggregate demand and supply that we teach to undergraduates and that bears little or no relationship to what Keynes meant by these terms” (Farmer 2007, p. 20).
Measuring a given nominal amount in units of money wages simply means dividing this nominal amount by the nominal wage rate w. The result is the real amount of labour units (either workers or working hours) that can be bought by a given monetary expenditure.
If total costs TC are given by salaries wL plus non-labour costs rK, i.e. TC = wL + rK, then the average output cost is given by \(\frac{{TC}}{Y} = \frac{w}{\alpha }{\left( {1 + \eta } \right)}\) where \(\eta = \frac{{rK}}{{wL}}\) is the share of non-labour costs over labour costs. Note that a sufficiently high mark-up, higher than η, guarantees a positive profit per unit of real output because µ > η implies \(p >\frac{{TC}}{Y}\). So, the mark-up level can be divided in two components: a cost-recovering component η and a pure profit margin λ, such that µ = η + λ.
Note that the MPR schedule shifts upward if the average labour productivity increases.
Note that the argument that a money-wage reduction does not necessarily imply an employment increase, proposed by Keynes in the famous Chapter 19 of The General Theory, is more complex than the one presented above for several reasons including the fact that Keynes does not use a mark-up pricing rule. A discussion of this issue within the framework proposed by Dalziel and Lavoie (2003) can be found in Andini (2006).
References
Andini, C. (2006). Teaching Keynes’s principle of effective demand and Chapter 19. CEEAplA Working Papers, no. 5, Centre of Applied Economic Studies of the Atlantic, April.
Asimakopulos, A. (1975). A Kaleckian theory of income distribution. Canadian Journal of Economics, 8(3), 313–333.
Barro, J., & Grossman, H. (1971). A general disequilibrium model of income and employment. American Economic Review, 61(1), 82–93.
Blanchard, O. (2000). Macroeconomics. Upper Saddle River: Prentice Hall.
Dalziel, P., & Lavoie, M. (2003). Teaching Keynes’s principle of effective demand using the aggregate labor market diagram. Journal of Economic Education, 34(4), 333–340.
Davidson, P. (1983). The marginal product curve is not the demand curve for labor and Lucas’s labor supply function is not the supply curve for labor in the real world. Journal of Post Keynesian Economics, 6(1), 105–117.
Davidson, P. (1994). Post Keynesian macroeconomic theory: A foundation for successful economic policies for the twenty-first century. Cheltenham: Edward Elgar.
Davidson, P. (1998). Post Keynesian employment analysis and the macroeconomics of OECD unemployment. Economic Journal, 108(448), 817–831.
Davidson, P. (2005). Responses to Lavoie, King and Dow on what post Keynesianism is and who is a post Keynesian. Journal of Post Keynesian Economics, 27(3), 393–408.
Farmer, R. E. (2007). Aggregate demand and supply. NBER Working Papers, no. 13406, National Bureau of Economic Research, August.
Harris, D. J. (1974). The price policy of firms, the level of employment and the distribution of income in the short run. Australian Economic Papers, 13(22), 144–151.
Keynes, J. M. (1936). The general theory of employment, interest, and money. New York: Harcourt, Brace & Co.
King, J. E. (2005). Unwarping the record: a reply to Paul Davidson. Journal of Post Keynesian Economics, 27(3), 377–384.
Kniesner, T. J., & Goldsmith, A. H. (1987). A survey of alternative models of the aggregate US labor market. Journal of Economic Literature, 25(3), 1241–1280.
Knoedler, J. T., & Underwood, D. A. (2003). Teaching the principles of economics: A proposal for a multi-paradigmatic approach. Journal of Economic Issues, 37(3), 697–725.
Lavoie, M. (2003). Real wages and unemployment with effective and notional demand for labor. Review of Radical Political Economics, 35(2), 166–182.
Lavoie, M. (2005). Changing definitions: A comment on Paul Davidson’s critique of King’s history of post Keynesianism. Journal of Post Keynesian Economics, 27(3), 371–376.
Mott, T., & Slattery, E. (1994). The influence of changes in income distribution on aggregate demand in a Kaleckian model: Stagnation vs. exhilaration reconsidered. In P. Davidson & J. A. Kregel (Eds.), Employment, growth and finance. Aldershot: Edward Elgar.
Patinkin, D. (1956). Money, interest, and prices. Evanston: Row, Peterson & Co.
Samuelson, P. A. (1948). The simple mathematics of income determination. In L. A. Metzler, et al. (Eds.),Income, employment, and public policy: Essays in honor of Alvin H. Hansen. New York: Norton.
Acknowledgments
Financial support from the Fundação para a Ciência e a Tecnologia (FCT) is gratefully acknowledged. I am indebted to Marc Lavoie, Paul Davidson, Steve Fleetwood, Dorene Isenberg, Gary Mongiovi, Brigitte Bechtold, Goeffrey Schneider and two anonymous referees for their useful comments and suggestions. I would also like to thank Giancarlo de Vivo and Fernando Vianello for their inspiring lectures on the economics of John Maynard Keynes. The usual disclaimer applies.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Andini, C. Teaching Keynes’s Principle of Effective Demand within the Real Wage vs. Employment Space. For Soc Econ 38, 209–228 (2009). https://doi.org/10.1007/s12143-009-9035-z
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s12143-009-9035-z