Keynesian theory

Economic theory before Keynes

Economic theory before Keynes was mainly concerned with the behaviour of individual producers and consumers and with buying and selling transactions between them. A central concept was that of a well-informed market in which transactions are made by bargaining. In such a market demand is brought into line with supply by price adjustments so that anything offered for sale is in fact sold. The patterns of prices emerging in such markets serve as signals to producers concerning the preferences of consumers, in response to which producers make any necessary adjustments to the pattern of production. Surpluses or shortages could arise when tastes change or harvests are bad' but they would be temporary which would disappear in due course as a result of the normal working of markets. This was no more than an idealised description of the sort of behabiour that could be observed in the markets for internationally-traded commodities such as metals, wheat and coffee.

The next-and crucial - step was the assumption that what was true of the supply and demand for individual products would also be true of the total levels of supply and demand in the economy as a whole.: namely that there could be no persistent shortages or surpluses. On this assumption. the explanation for any departure from that theoretical conclusion - the occurrence, for example of mass unemployment - must lie in deficiences in the market mechanism, and the remedy must be the correction of such deficiencies.

The Keynesian revolution

The study of macroeconomics, to which Keynes made a major contribution, takes an entirely different approach. Instead of inferring the behaviour of the conomy as a whole from what could be observed about individual behaviour, it deals directly with what can be observed about economy-wide totals.

The ultimate economy-wide total in macroeconomics is national incme, which can br defined either as the total of the incomes of all the households in the country