"The Propensity to Consume
Keynes was certainly not the first economist to try and apply mathematical exactitude to the economic problem. A Frenchman, Augustin Cournot, in his Recherches sur les principes mathematiques de la theorie des richesses published in 1838, introduced the ubiquitous supply and demand curves that were popularised within Marshallian mathematical economics, even though Marshall himself derided their use.
Keynes, I suspect, borrowed from Cournot, in devising his theory of the Propensity to Consume. From The General Theory…
The ultimate object of our analysis is to discover what determines the volume of employment. So far as we have established the preliminary conclusion that the volume of employment is determined by the point of intersection of the aggregate supply function with the aggregate demand function
Highlighted, are the mathematics to follow, that really are no mathematics at all.
Let Z be the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z = ~[N], which can be called the Aggregate Supply Function.
Similarly, let D be the proceeds which entrepreneurs expect to receive from the employment of N men, the relationship between D and N being written D = f[N] which can be called the Aggregate Demand Function
Thus we have from Keynes, two mathematical equations that describe a complex relationship, who’s intersection, determines the volume of employment. Do entrepreneurs actually wake up and think…if I hire X number of men, my profit will equate to Y?
I hardly think so. Entrepreneurs will think, if I can produce this product or service, what is the maximum price that I can charge the market, and still hope to sell a certain number of units? I have a specific amount of capital available to invest, what costs can I incur in the manufacture, and still retain an attractive profit?
At this point, our intrepid entrepreneur decides how much employment he can afford. Should, the volume of employment decide his profit, he would hire as many workers as possible, as his profit becomes a function of the [N] of employees.
The Aggregate Supply Function depends upon two actualities, viz. supply price + number of men employed. However, the Aggregate Demand Function depends upon an expectation of proceeds [profit].
The mathematical equations therefore hide the fact that an actuality is being equated with an expectation, in a quantifiable and precise manner, to determine the volume of employment.
This theory, which is patently nonsense, seemingly underlies the justification of massive deficit spending within the make-work-schemes that governments love to implement.
Returning to our Frenchman, who started this unseemly mess with his supply/demand curve mathematics…there is little if any proof that functional economic equations represents a fact of reality. Hypothetically speaking, they [equations] provide a model: that when we draw a hypothetical demand curve, and derive from it a hypothetical functional relationship twixt demand and price, we can state that at price x the demand for x will be y.
These curves are analogies, metaphors, visual aids, in short, models, which should never be confused with actual realities.
Financial markets turn the supply/demand theory on it’s head, particularly during the building of a bubble, where, as price rises, ever greater volumes are demanded.
The point being, that the mathematical functions posited by Keynes cannot be proven. They simply can be asserted, in a dogmatic fashion.
The Propensity to Consume, relies also upon The Fundamental Psychological Law, which I shall look at next."