Context
Published during the Great Depression, Keynes challenged classical economics, which failed to explain persistent unemployment. He argued that economies could remain in prolonged downturns without intervention, overturning the classical belief in self-correcting markets.
Core Theories
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Aggregate Demand Drives Economies
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Problem: Insufficient demand causes unemployment.
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Key Insight: Total spending (consumption + investment + government spending) determines output and employment.
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Say’s Law Rebuttal: Supply does not automatically create demand; demand shortfalls can persist.
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Effective Demand
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Employment depends on businesses’ expectations of sales (demand). Pessimism reduces hiring, creating cyclical unemployment.
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Liquidity Preference Theory
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Interest rates reflect the desire to hold cash (liquidity). High rates discourage investment, worsening economic slumps.
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Multiplier Effect
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Government spending (e.g., infrastructure) stimulates further spending:
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Example: 1billioninspending→1.5 billion GDP increase via worker consumption.
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Animal Spirits
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Investor confidence is driven by psychology, not rationality, leading to volatile investment and business cycles.
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Policy Implications
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Government Intervention: Advocate for fiscal policy (spending/tax cuts) during recessions to boost demand.
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Counter-Cyclical Measures: Deficit spending in downturns, repaid during booms.
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Rejection of Austerity: Cutting spending during crises deepens recessions.
Contrast with Classical Economics
| Classical View | Keynesian View |
|---|---|
| Markets self-correct | Markets stagnate without intervention |
| “Laissez-faire” policy | Active fiscal/monetary policy |
| Flexible wages/prices | “Sticky” wages/prices delay recovery |
Legacy
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Post-WWII Dominance: Shaped New Deal and Bretton Woods systems.
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1970s Critique: Stagflation challenged Keynesianism, boosting monetarism (Friedman).
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Modern Revival: 2008 crisis and COVID-19 saw Keynesian stimulus resurgence.
Key Quote:
“The difficulty lies not so much in developing new ideas as in escaping from old ones.”
In Short: Keynes redefined economics by prioritizing demand management and justifying government intervention to stabilize economies—a legacy enduring in modern policy.
