Effective Demand and Short-term Adjustments in the General Theory

Abstract

Keynes's principle of effective demand constitutes a pillar for Post Keynesian theories. But Keynes's presentation remains difficult to interpret, mainly because the aggregate demand function is based on entrepreneurs' expectations. The problem is, then, to demonstrate how these entrepreneurs (whose only concern is making profits) are led to generate the effective demand (which partially results from the consumers' and investors' behaviour). Previous studies by authors such as Weintraub and Davidson highlight the trial-and-error procedure here involved. But since their analyses are not built on a precise accounting of monetary flows, they fail to demonstrate formally the coherence of the whole adjustment process. The aim of this article is to provide such a formal demonstration. We thus concentrate on verifying how the General Theory constitutes a coherent framework to analyse temporary equilibriums (at the end of every elementary period) and short-term dynamics (towards the stationary equilibrium) which bring entrepreneurs towards the stationary equilibrium. Our analysis rests on a distinction between the aggregate demand and the global expenditure functions. We also distinguish between two modes of price setting—ex ante price setting by entrepreneurs, and ex post price setting by the market.

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