Keynes vs. the Post Keynesians on the Principle of Effective Demand *

* I would like to thank Michael E. Brady, Dany Lang, Marc Lavoie, Roy Rotheim, Mark Setterfield and two anonymous referees of this journal for their valuable comments. All remaining shortcomings are my own.

Abstract

The American Post Keynesians – those who attach importance to the capital ‘P’ and the absence of a hyphen between ‘post’ and ‘Keynesian’– claim to be Keynes' most literal interpreters or the ‘truest’ Keynesians (Holt et al. 1998: 17). This paper compares the Post Keynesian interpretation of the Principle of Effective Demand, i.e. the D/Z-model, with Keynes' own presentation in chapter 3 of the General Theory– and finds substantial differences. A re-interpretation of the D/Z-model is offered that would bring it into line with chapter 3.

Keywords:

• Effective demand
• Post Keynesianism
• D/Z-model

Notes

* I would like to thank Michael E. Brady, Dany Lang, Marc Lavoie, Roy Rotheim, Mark Setterfield and two anonymous referees of this journal for their valuable comments. All remaining shortcomings are my own.

1 King (1994) scrutinizes the early stages of non-Post Keynesian aggregate supply and demand analysis. ‘To conclude that there was some confusion about aggregate supply and demand analysis in the early 1950s would be a grotesque understatement’, he resumes (p. 14).

2 Weintraub (1958) reprints two earlier articles (Weintraub 1956, 1957) with minor alterations.

3 But also note Fontana's (2004: 79) argument: ‘Besides, as he [Hicks] explains, when agents make decisions they have in mind a stage-by-stage temporal frame. It was not only for theoretical convenience but also for the realism of the study that period analysis had to be considered superior to continuous analysis’.

4 Nell presents the same argument somewhat differently: ‘Continuous output should not be overstressed. Even under Mass Production the seasons, traditional holidays and social customs provide a framework that sets definitive marketing dates toward which manufactures aim. … So, while under continuous production there need be no common starting and finishing points, these will often exist, nevertheless’ (Nell 1998: 205).

5 Cf. Amadeo (1989: 105, fn. 1). Keynes' acceptance of the ‘first classical postulate’ (cf. Keynes 1973a: 17 – 8) implies three assumptions that stem from (neo)classical theory. First, competition is assumed to be, if not perfect, so at least ‘free’ (in a Marshallian sense). This means that firms are unable to dictate the market price for the commodities they produce – or, put another way, that entrepreneurs expect to face a highly price-elastic demand. The second assumption is that firms maximize profits. Finally, decreasing marginal returns to labour are assumed (cf. Roberts 1978: 558, Koenig 1980: 447, Amadeo 1989: 13, Palley 1997: 296).

6 In terms of Keynes (1973a, ch. 6), the only relevant cost component entrepreneurs are not certain about (and that is thus subject to expectation-building) are user costs; cf. Koenig (1980: 432 – 5) for a thoughtful discussion of this issue. But user costs do not enter Z (cf. Keynes 1973a: 24, fn. 2). We can thus take all the cost components that do enter Z to be known to entrepreneurs.

7 Keynes seems to assume that the profit share rises with employment (cf. Keynes 1973a: 17, fn. 1).

8 In his excellent reconstruction of the microfoundations of Keynes' theory, Koenig (1980: 435) writes: ‘The figures p_j q_j correspond to the monetary proceeds the producers must have in order to maximise their profits. The entrepreneurs compare these proceeds with those they can hope to receive from the sale of their products and which are based on their anticipations with respect to demand’ (authors translation, italics added). A similar presentation can be found in a textbook from the early 1950s (cf. Stonier and Hague 1953: 381 – 8).

9 This point has been made before by Torr (1984: 939), who sees ‘convincing evidence in chapter 19 [of the General Theory] that these firms [the small firms Keynes assumes] do not believe that they have unlimited sales opportunities’. Chick (1983: 24 – 6) and elaborated in Chick (1992) points out that price-taking is impossible, even for the small firm, under uncertainty and in the latter proposes an approach that keeps the small firm but scraps price-taking. This resembles Richard Kahn's (1989: 12 – 3; though written 1929) notion of ‘polypoly’, where there are many small firms in a market, but differences of market prices may nevertheless persist over an appreciable period of time.

10 On page 259 of the General Theory Keynes mentions ‘aggregate effective demand’. Here, he refers to the aggregate demand that has been realised ex post. Contrary to this practice, one should distinguish carefully between ‘effective demand’ (the point of intersection of the D- and Z-curve), ‘aggregate demand curve’ (the D-curve in expectation terms), and ‘aggregate demand’ as realised ex post.

11 Only if the production periods are definitively short, the impression of quantity reactions might arise. This theoretical possibility – which is probably not very relevant in practice since real production periods tend to be longer than the ‘Keynesian day’ (see above) – should not eclipse the insight that quantity reactions lie outside the proper scope of the Principle of Effective Demand.

12 Note that this approach is very similar to Hicks' distinction between ‘single period theory’ and ‘continuation theory’. A disequilibrium in the ‘single period’ subsequently leads to different expectations on the part of the entrepreneurs and to adaptations of their decisions. ‘Continuation theory’ then traces out the succession of those periods (cf. Hicks 1982, 1985, Fontana 2004).