The Summary of the General Theory

January 10, 2020

My proposed system has the following as a given:

  • the existing skill and quantity of available labour
  • the existing quality and quantity of available equipment
  • the existing technique
  • the degree of competition
  • the tastes and habits of the consumer
  • the disutility of different intensifies of labour and of the activities of supervision and organisation, as well as the social structure including the forces, other than our variables set forth below, which determine the distribution of the national income.

This does not mean that we assume these factors to be constant.

In this place and context, we are merely not considering or taking into account the effects and consequences of changes in them.

My system’s independent variables are:

  • the propensity to consume
  • the schedule of the marginal efficiency of capital
  • the rate of interest

These can be analyzed further.

My system’s dependent variables are:

  • the volume of employment
  • the national income (or national dividend) measured in wage-units.

The factors, taken as given, influence our independent variables, but do not completely determine them.

For example, the schedule of the marginal efficiency of capital depends partly on the existing quantity of equipment which is one of the given factors, but partly on the state of long-term expectation which cannot be inferred from the given factors.

But there are certain other elements which the given factors determine so completely that we can treat these derivatives as being themselves given.

For example, the given factors allow us to infer what level of national income measured in terms of the wage-unit will correspond to any given level of employment; so that, within the economic framework which we take as given, the national income depends on the volume of employment, i.e. on the quantity of effort currently devoted to production, in the sense that there is a unique correlation between the two.[1]

Furthermore, they allow us to infer the shape of the aggregate supply functions, which embody the physical conditions of supply, for different types of products; — that is to say, the quantity of employment which will be devoted to production corresponding to any given level of effective demand measured in terms of wage-units. Finally, they furnish us with the supply function of labour (or effort); so that they tell us inter alia at what point the employment function[2] for labour as a whole will cease to be elastic.

The schedule of the marginal efficiency of capital depends, however, partly on the given factors and partly on the prospective yield of capital-assets of different kinds; whilst the rate of interest depends partly on the state of liquidity-preference (i.e. on the liquidity function) and partly on the quantity of money measured in terms of wage-units. Thus we can sometimes regard our ultimate independent variables as consisting of:

  1. The three fundamental psychological factors, namely, the psychological propensity to consume, the psychological attitude to liquidity and the psychological expectation of future yield from capital-assets
  2. The wage-unit as determined by the bargains reached between employers and employed
  3. The quantity of money as determined by the action of the central bank; so that, if we take as given the factors specified above, these variables determine the national income (or dividend) and the quantity of employment. But these again would be capable of being subjected to further analysis, and are not, so to speak, our ultimate atomic independent elements.

The division of the determinants of the economic system into the two groups of given factors and independent variables is, of course, quite arbitrary from any absolute standpoint. The division must be made entirely on the basis of experience, so as to correspond on the one hand to the factors in which the changes seem to be so slow or so little relevant as to have only a small and comparatively negligible short-term influence on our quaesitum; and on the other hand to those factors in which the changes are found in practice to exercise a dominant influence on our quaesitum.

Our present object is to discover what determines at any time the national income of a given economic system and (which is almost the same thing) the amount of its employment; which means in a study so complex as economics, in which we cannot hope to make completely accurate generalisations, the factors whose changes mainly determine our quaesitum.

Our final task might be to select those variables which can be deliberately controlled or managed by central authority in the kind of system in which we actually live.

II

There will be an inducement to push the rate of new investment to the point which forces the supply-price of each type of capital-asset to a figure which, taken in conjunction with its prospective yield, brings the marginal efficiency of capital in general to approximate equality with the rate of interest.

That is to say, the physical conditions of supply in the capital-goods industries, the state of confidence concerning the prospective yield, the psychological attitude to liquidity and the quantity of money (preferably calculated in terms of wage-units) determine, between them, the rate of new investment. But an increase (or decrease) in the rate of investment will have to carry with it an increase (or decrease) in the rate of consumption; because the behaviour of the public is, in general, of such a character that they are only willing to widen (or narrow) the gap between their income and their consumption if their income is being increased (or diminished).

That is, changes in the rate of consumption are, in general, in the same direction (though smaller in amount) as changes in the rate of income.

The relation between the increment of consumption which has to accompany a given increment of saving is given by the marginal propensity to consume.

The ratio, thus determined, between an increment of investment and the corresponding increment of aggregate income, both measured in wage-units, is given by the investment multiplier.

Finally, if we assume (as a first approximation) that the employment multiplier is equal to the investment multiplier, we can, by applying the multiplier to the increment (or decrement) in the rate of investment brought about by the factors first described, infer the increment of employment. An increment (or decrement) of employment is liable, however, to raise (or lower) the schedule of liquidity-preference; there being three ways in which it will tend to increase the demand for money, inasmuch as the value of output will rise when employment increases even if the wage-unit and prices (in terms of the wage-unit) are unchanged, but, in addition, the wage-unit itself will tend to rise as employment improves, and the increase in output will be accompanied by a rise of prices (in terms of the wage-unit) owing to increasing cost in the short period.

Thus the position of equilibrium will be influenced by these repercussions; and there are other repercussions also. Moreover, there is not one of the above factors which is not liable to change without much warning, and sometimes substantially. Hence the extreme complexity of the actual course of events. Nevertheless, these seem to be the factors which it is useful and convenient to isolate.

If we examine any actual problem along the lines of the above schematism, we shall find it more manageable; and our practical intuition (which can take account of a more detailed complex of facts than can be treated on general principles) will be offered a less intractable material upon which to work.

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