Chapter 96: Keynesian and Post-Keynesian Demand, Money, and Instability. The Encyclopedia of Economic Principals, interactive companion

Every example here is a constructed teaching example: it uses the hypothetical numbers of the chapter's worked examples, plus a few values added for comparison and labelled as such in each panel. Nothing here measures a real market, firm or household.

Demonstration 1 of 4

Wage cuts and the paradox of costs

If every firm cuts the wage share, do aggregate profits rise?

One firm that cuts wages keeps its sales; all firms together cut their customers' income. Consumption falls, output and utilization fall, and realized profits are set by the spending that is not financed by wages, here twice autonomous demand.

$Equation, written in LaTeX: \Pi=(1-\omega)Y.$

Equation, written in LaTeX: 60+0.5(40)+20=100,

Equation, written in LaTeX: Y=0.75Y+20,

Scroll sideways for the whole equation

Y is output, omega the wage share and Pi = (1 - omega) Y realized profits. Workers spend all wages, profit recipients spend half of profits, and autonomous demand (investment plus extra exports) is A. Capacity is 125.

Predict first. Cutting the wage share from 0.60 to 0.50 with autonomous demand 20: do profits rise?

Your prediction Yes, profits rise No, profits stay at 40 while output falls to 80 Profits fall

Wage share

Autonomous demand (investment plus exports)

Figure: Wage cuts and the paradox of costs. Left: a 45 degree diagram with expenditure line slope 0.80 meeting the 45 degree line at Y = 100.00, capacity at 125. Right: bars of output 100.00 and profits 40.00. — Wage share: 0.6, Autonomous demand (investment plus exports): 20
Constructed example: the chapter's hypothetical values are capacity 125, wage shares 0.60 and 0.50, spending propensities 1 and 0.5, and autonomous demand 16, 20 and 30; a wage share of 0.70 is added.

Spending propensity: 0.80
Output Y: 100.00
Profits: 40.00
Utilization u: 0.800
Profit rate on capacity: 0.320

Hypothetical teaching numbers, not data. With wage share 0.60, every unit of output brings 0.80 of consumption, so Y = 20 / 0.20 = 100.00 and profits are 0.40 x 100.00 = 40.00. Utilization is 100.00 / 125 = 0.800 and the profit rate on capacity is 40.00 / 125 = 0.320. In this model profits equal twice autonomous demand whatever the wage share: a wage cut raises the profit share but shrinks output.

Worked steps

Propensity = 1 x 0.60 + 0.5 x 0.40 = 0.80
Y = 20 / (1 - 0.80) = 20 / 0.20 = 100.00
Profits = 0.40 x 100.00 = 40.00
Profit rate on capacity = 40.00 / 125 = 0.320

Use the idea

Before arguing that a general wage cut raises profits, say which spending (investment, exports, deficits) replaces the lost wage consumption.

Where the conclusion applies

Fixed prices, a closed economy, fixed spending propensities and autonomous demand set outside the model, as in the chapter's hypothetical case.

Check your understanding: With wage share 0.70 and autonomous demand 16, what are Y and profits?

Propensity 0.85, so Y = 16 / 0.15 = 106.67 and profits 0.30 x 106.67 = 32.

Chapter 96 source: section "Paradox of costs".

Demonstration 2 of 4

What determines aggregate profits

Which spending flows add up to aggregate profit, and what offsets a smaller deficit?

The equation is an identity: aggregate profits are the spending that does not come out of wages, minus what wage earners save. A forecast that keeps profits at 160 after a smaller deficit must name the offset, such as 15 more investment and 5 less worker saving.

Equation, written in LaTeX: P=C_c+I+(G-T)+(X-M)-S_w.

Equation, written in LaTeX: P=40+120+30-10-20=160.

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P is aggregate profit, C_c capitalist consumption, I investment, G - T the government deficit, X - M net exports and S_w saving out of wages, all in hypothetical billions per year.

Predict first. The deficit falls by 20 with nothing else changing. What happens to profits?

Your prediction They fall by 20, to 140 They stay at 160 They fall by more than 20

Government deficit

Investment

Worker saving

Government deficit: 30
Investment: 120
Worker saving: 20
Profits P: 160
Change from book's 160: 0

Hypothetical teaching numbers, not data. Profits equal 40 + 120 + 30 - 10 - 20 = 160 billion. Each unit of investment or deficit adds one to profits and each unit of worker saving subtracts one, holding the other entries fixed.

Worked steps

P = C_c + I + (G - T) + (X - M) - S_w
P = 40 + 120 + 30 - 10 - 20
P = 160

Use the idea

When a plan cuts one injection, list which other entry is expected to replace it before assuming profits hold up.

Where the conclusion applies

Consistent sector boundaries and timing; the identity says nothing about which entry causes which, as the chapter stresses.

Check your understanding: With deficit 10, investment 120 and worker saving 15, what are profits?

40 + 120 + 10 - 10 - 15 = 145.

Chapter 96 source: section "Kalecki profit equation".

Demonstration 3 of 4

Effective demand below capacity

Why can output settle at 120 when capacity is 160, and what does a public order do?

Expected sales select production. With idle capacity, more expected spending raises output and income, which raises consumption again, until expected and realized sales agree.

Equation, written in LaTeX: D^e(N^*)=Z(N^*).

Equation, written in LaTeX: Y=20+0.75Y+10,

Equation, written in LaTeX: Y=20+0.75Y+10+8

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Consumption is C = 20 + mpc Y, investment is 10, G is a credible public order and capacity is 160 units, with one worker per unit. D^e is expected proceeds and Z the aggregate supply price.

Predict first. How much does a credible 8 unit public order raise output at mpc 0.75?

Your prediction By 8 By 32, to 152 To full capacity, 160

Public order

Marginal propensity to consume

Figure: Effective demand below capacity. Keynesian cross: expenditure line with intercept 30 and slope 0.75 meets the 45 degree line at Y = 120.00; capacity line at 160. — Public order: 0, Marginal propensity to consume: 0.75
Constructed example: the chapter's hypothetical values are C = 20 + 0.75Y, investment 10, capacity 160 and orders 0, 8 and 10; an mpc of 0.70 is added.

Autonomous spending: 30
Multiplier: 4.00
Output Y: 120.00
Idle capacity (workers): 40.00

Hypothetical teaching numbers, not data. Firms produce what they expect to sell: Y = 30 / 0.25 = 120.00, so 40.00 units of capacity and 40.00 workers stay idle. With no public order, output is set by private demand alone.

Worked steps

Y = 20 + 0.75Y + 10 + 0
Y = 30 / (1 - 0.75) = 30 / 0.25 = 120.00
Idle = 160 - 120.00 = 40.00

Use the idea

Ask whether there is slack before predicting that extra demand raises output rather than prices.

Where the conclusion applies

Fixed planning-period prices, a closed economy and a public order that firms believe.

Check your understanding: With mpc 0.70 and an 8 unit order, what is Y?

Y = (20 + 10 + 8) / 0.30 = 126.67.

Chapter 96 source: section "Principle of effective demand".

Demonstration 4 of 4

Markup pricing and demand shocks

Under a normal-cost rule, does a temporary fall in orders change price or margin?

Firms that price on normal cost let quantity and profit absorb demand shocks; cost shocks, such as a higher direct cost, pass into price. Pricing on current volume would instead raise price when orders fall.

$Equation, written in LaTeX: c_n=v_n+\frac{K}{Q_n}, P=(1+m)c_n.$

$Equation, written in LaTeX: 60+\frac{2{,}000{,}000}{100{,}000}=80,$

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v is direct unit cost, K = 2,000,000 overhead, Q_n = 100,000 normal volume, c_n normal unit cost and m = 0.25 the markup. Current orders may differ from normal volume.

Predict first. Orders fall to 70,000 under the normal-cost rule. Does the quoted price change?

Your prediction No, it stays at 100 and the margin falls Yes, it rises to cover overhead

Direct unit cost

Overhead base

Current orders

Figure: Markup pricing and demand shocks. Two stacked bars: quoted price 100.00 built from direct cost 60, overhead 20.00 and markup 20.00; actual unit cost 88.57. — Direct unit cost: 60, Overhead base: Normal volume, Current orders: 70,000
Constructed example: all values (overhead 2,000,000, volumes 100,000 and 70,000, direct cost 60 and 68, markup 0.25) are the chapter's hypothetical numbers.

Overhead base: normal volume 100,000
Unit cost for pricing: 80.00
Quoted price: 100.00
Actual unit cost: 88.57
Realized margin: 11.43

Hypothetical teaching numbers, not data. Spreading overhead over normal volume 100,000 gives a pricing cost of 80.00 and a quoted price of 1.25 x 80.00 = 100.00. With 70,000 orders the actual unit cost is 88.57, so the realized margin is 11.43 per unit.

Worked steps

Unit cost for pricing = 60 + 2,000,000 / 100,000 = 60 + 20.00 = 80.00
Price = 1.25 x 80.00 = 100.00
Actual cost = 60 + 2,000,000 / 70,000 = 88.57
Margin = 100.00 - 88.57 = 11.43

Use the idea

To test whether a firm prices on normal cost, check whether its list price moves with direct cost but not with temporary changes in orders.

Where the conclusion applies

A fixed markup and normal volume, as in the chapter's hypothetical producer.

Check your understanding: With direct cost 68, current-volume overhead and 100,000 orders, what is the price?

1.25 x (68 + 20) = 110, the same as the normal rule because orders equal normal volume.

Chapter 96 source: section "Administered full-cost pricing".

Wage cuts and the paradox of costs

Choose an example

Calculated values

Worked steps

Use the idea

Where the conclusion applies

What determines aggregate profits

Choose an example

Calculated values

Worked steps

Use the idea

Where the conclusion applies

Effective demand below capacity

Choose an example

Calculated values

Worked steps

Use the idea

Where the conclusion applies

Markup pricing and demand shocks

Choose an example

Calculated values

Worked steps

Use the idea

Where the conclusion applies