EC_224_Lecture 8_Kaleckian_Effective_Demand

1.

EC 224
Intermediate Macroeconomics
Kaleckian Effective Demand
Lavoie, Introduction to Post-Keynesian Economics, Chapter 4
Lavoie, Post-Keynesian Economics: New Foundations, Chapter 5

2.

Post-Keynesian Economics and Effective Demand
Labour Market
• A major difference between neoclassical and Post-Keynesian economics is
the treatment of labour market.
• Labour is considered like any other commodity in the neo-classical
approach and obeys the rules of supply and demand.
• Real wages move up or down in order to ensure equilibrium in the labour
market (although the models include sticky wages, it is movements in the
real wage which bring the labour market to equilibrium in the end)
• In Post-Keynesian economics, the labour market does not exist in the true
sense
• Capital and labour can only be combined in fixed proportions in the short
run, and substitution between factors of production is not possible.

3.

• The negative relationship between labour demand and real wages does not take
into account considerations on demand. (i.e whether or not what is being
produced can be sold)
• The demand for labour and labour supply may not be well-behaved as in the
neo-classical model and might have a backward bending/forward leaning shape,
leading to multiple equilibria in the labour market.
• This would mean there are several (at least two) different levels of real wage for
which the labour markets would be in equilibrium

4.

5.

Effective Demand
• The analysis of unemployment and production must take into account the
demand constraint, which is the binding condition.
• Production and employment are determined by the level of effective demand at
the macroeconomic level. Unemployment is not caused by high wages or sticky
wages. In general, unemployment and under-utilization or productive capacity
are due to lack of effective demand in the economy as Say’s law does not hold.
• We say in general because in some cases, there might be supply constraints on
the level of productive capacity and unemployment may be arising because the
even the existing full productive capacity may not create enough employment
for the labour force.

6.

Jean Baptiste Say (1767-1832)
• Say’s Law: Supply creates its own demand. Savings are invested in the
economy, which is purchasing of goods, and therefore creates demand. So
there cannot be any overproduction or unemployment.
• Endorsed by Ricardo as well, but refuted by Marx in Das Kapital, and
Keynes in the General Theory from different perspectives (As well as by
Kalecki at the same time with Keynes)

7.

Marxist Reproduction Schemas
• The objective of the capitalist is to generate profits.
M – C --- P --- C’ – M’
• Production starts when capitalists invest an initial amount of money, M, and
initiate the production process. With this “capital”, the capitalist purchases
means of production (inputs and labour power) C. Through the production
process, a new commodity C’, which contains more labour, is produced.

8.

M – C/V --- P --- C’/V –M’
• This new commodity C’ is then sold in the market at the price p (exchange
value), which is determined by the socially necessary labour time required to
produce the commodity (Labour theory of value)
• Therefore, C’ is transformed into M’, where M’ > M by definition (As
according to Marx, the capitalist pays the labourer only a fraction of his time,
which is the amount necessary to reproduce the labourer and by definition less
than the value created by the labourer during total working hours). Then:
• (M’ – M)V = Monetary profits in one circuit where V = Velocity of money

9.

• The straightforward question then is: Where does the additional money (M’ M) come from so that the surplus value can be realized?
• ‘It is the capitalist class itself that throws the money into circulation which serves for the
realisation of the surplus-value incorporated in the commodities. But, nota bene, it does not
throw it into circulation as advanced money, hence not as capital. It spends it as a means of purchase for its
individual consumption’ (Marx, 1956: 338-39)

10.

• The money necessary to realize the surplus is already in the hands of the capitalists.
So all they need to do is to consume during the circuit, which will lead to the
realization of the profits. In order to realize the whole surplus, the entire M’ – M
must be consumed by the capitalists.
• So realization of the surplus value depends on the capitalists’ consumption
decisions. According to Marx, when capitalists decide to hoard money rather than
consuming (loss of confidence or fall in expected profits), there will be an
overproduction crisis, as surplus value will not be fully realized.
• This is the analysis with simple reproduction. With expanded reproduction where
capitalists invest as well, capitalists need not consume the full difference between
(M’ – M), part of this amount can be invested to expand.
• Then, the surplus value that will be realized will depend on investment plus
capitalists’ consumption.
.

11.

• In expanded reproduction, as productive capacity grows, total amount that
needs to be spent by the capitalists (M’-M) will increase through time. Marx
contends that capitalists’ consumption cannot keep up with this increase, and
money supply will have to increase to ensure realization of surplus value can
continue. (The role of banks in capitalist crisis)
• So Say’s law does not hold, overproduction crisis and unemployment are
endogenous and inherent to capitalism.

12.

Kaleckian Effective Demand
• The Kaleckian version of the effective demand model rejects the production
function with diminishing returns to labour.
• Assume constant marginal costs until full capacity for the firms.
• Capital and labour combine only in fixed proportions, and they cannot be
substituted for each other.
• Production can be increased by employing more labour at constant marginal
cost and utilizing more of the existing machinery.
• Instead of a production function, we will use a utilization function which
connects output to labour productivity.

13.

The Model
q = Output
yത = Output per worker = Labour productivity = q/L
which by definition gives