The Keynesian Revolution & the dominant view before Keynes’ General Theory

Dominant View before Keynes A “free market system” has some powerful equilibrating forces The economy is like a large sailboat with a deep and heavy keel If it gets hit broadside with a wave, it go off-center but will right itself on its own Is there a need for the government or central bank to correct periods of imbalance?

Say’s Law of Markets: Basis of the Pre-Keynesian View Supply Creates its Own Demand If Demand is shocked downward in one area, will other areas be dragged down as well? What will companies do if they have excess inventories?

Say’s Law: the equilibrating mechanism Producers adjust prices faster than quantities produced If demand drops in one sector, what will companies do to get rid of excess inventories? If savings exceeds investment, what will happen to interest rates? If there is high unemployment, will it last? What price will adjust?

Anomalies of Say’s Law (during the Great Depression) Prices dropped dramatically, demand did not rise Interest rates fell precipitously, investment did not increase Wages fell, unemployment lines lengthened

Say’s Law vs Keynes’ Law Supply Creates its own Demand Prices are more flexible than Quantities Demand creates Supply Firms adjust quantities produced first