Chapter 46: Keynesian Income Determination Diagrams
Michael Schneider In the General Theory, Keynes summarised his income determination theory, which he made clear applies only to a period short enough for the capacity-creating effects of investment to be ignored, as stating: (i) that ‘[i]n a given situation of technique, resources and costs’ (Keynes, 1936, p.28) income depends on the volume of employment; and (ii) that employment depends on an aggregate supply function Z = f(N), where N stands for employment and Z stands for the aggregate supply price of the output from employing N men, and an aggregate demand function D = f(N), where D stands for the sum of expected aggregate consumption expenditure (assumed to be an increasing function of N) and expected aggregate investment expenditure. It followed that employment, and therefore income, is determined by the equation f(N) = f(N), that is to say the condition that aggregate supply equals aggregate demand, the former being constrained by the latter. The principal policy implication of this theory is that if an increase in employment and income is desired, it may be necessary to increase aggregate demand. In his summary of his income determination theory, Keynes also stated that he would use wage units rather than prices as his measure of value, and that he would assume that ‘money wage and other factor costs are constant per unit of labour employed’ (Keynes, 1936, p.27), an assumption he made solely to simplify the exposition, which he was to drop later. An implication of these procedures is...
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