Name: Talha Saqib Marks__________

Lahore School of Economics

Growth Economics
Assignment 6

1. Summarize the chapter assigned to you from the book “The General Theory of
Employment, Interest, and Money” by John Maynard Keynes.
Chapter 8 tells us the possible factors of employment within and economy, initially and generally
it is believed that the intersection between the labor demand and supply tells us the level of
employment. Furthermore, it tells us how consumers consume their income at a given level of
employment as well. The income or proceeds are spent on 2 things, consumption and investment.
This chapter primarily focuses on the factors determining and explaining consumption.
Consumption (C) is composed of your income minus your taxes and the marginal propensity to
consume (MPC) is what proportion of your income you spend on consumption. MPC is the
functional relationship between Yw a given level of income in terms of wage-units, and Cw the
expenditure on consumption out of that level of income, so that
Cw = (Y w) or C = W (Yw).
Moreover, a societies consumption depends on
1) Partly the income
2) Partly on objective attendant circumstances
3) Partly on subjective needs, psychological propensities and habits of the individual
Factors which may cause a change in the propensity to consume of an individual include:
a) A change in the unit wage. Consumption is a direct function of real income rather than
nominal income. It will fluctuate with regards to change in wage units. Consumption is in
some way proportional to changes in real income, since as real income changes
consumption tends to change in the same direction.
b) Change in difference between income and net income: Before, Keynes had established
that consumption is based on net income (income minus supplementary costs [V]).
While he doesn’t put much importance on this factor, his basic point is that changes in
income that do not manifest in net income should not be considered, and changes in net
income that do not manifest in income should.
c) Windfall changes in capital-values not allowed for in net income. Windfall changes are
like supplementary costs, but unexpected. These are important to figuring consumption,
because they are unstable and unexpected. Keynes posits that this is more relevant for
the “wealth-owning class,” and not for changes in short period consumption patterns
d) Changes in rate-time discounting which is the ratio of exchange between present good
and future goods. Not exactly the same as the rate of interest, according to Keynes, but
approximate to it. According to the Classicals, a high rate of interest will cause
consumption to fall, but Keynes says this is not proven and perhaps doubtful. He says
Name: Talha Saqib Marks__________

that “short-period” changes will not affect the rate of consumption, for all practical
purposes. It may be relevant when they relate to the value of securities and other forms of
these types of asset investments. Changes in the rate of interest might have an effect if
they fluctuate wildly or dramatically, or if it pays to have a life annuity over saving
money (if the rate of interest is low enough). Lastly, maybe extreme uncertainty and its
effects on consumption might be relevant to this factor.
e) Changes in fiscal policy: Government policy can affect MPC. Taxes on unearned income
(capital-profits, death-duties, etc.), and redistribution policies, can all increase the rate of
consumption. On the other hand, payment of debt through sinking funds will decrease
consumption.
f) Changes in expectation of changes between present and future income: For society as a
whole, Keynes contends that this is not likely to be a major factor (since it will average
out between individuals).
Onwards Keynes talks about the shape of the consumption function, since the relationship
between Consumption and income is positive, it will be expected that the curve will be upward
sloping. However, the degree of change between income and consumption will different. One
unit increase in income will not necessarily result in a one-unit change in consumption.
However, if the absolute level of income of an individual increase, then the gap between income
and spending will widen which means savings would increase in that case and vice versa.
Lastly Keynes states that employment is a function of expected consumption and expected
investment, and consumption is a function of net income (which is consumption + net
investment), or more accurately net investment. Hence, the higher the savings the higher the
investment. The chapter is concluded with Keynes stating that capital goods are not self-
subsistent. A fall in the marginal propensity to consume will lead to a fall in demand for capital.