Toward a More Complete Model

In the last three chapters we have concentrated narrowly on the income-expenditure connection, and developed a model based on that connection and nothing else: the Simple Keynesian Model. That model provides a diagnosis for unemployment problems, and suggests some prescriptions that would be effective if the world were as simple as the model. But, in the real world, there are other influences and connections that we have not yet considered in the Keynesian model of aggregate demand. Among these are the monetary system and the quantity of money, the rate of interest on loans, and the influence of these on investment.

Keynes was well aware of the importance of these influences, and spent a large part of the book he called The General Theory of Employment, Interest and Money on them, as the title suggests.

Our objective in this chapter will be to bring those things into the model. In doing so, we will complete the Keynesian theory of aggregate demand. For that reason, the theory outlined in this chapter is called the "Complete Keynesian Model."

One way to look at the Complete Keynesian Model is to think of what some economists call "an aggregate demand curve" -- a curve relating the price level to the real GDP that people want to buy. Keynes use the term "aggregate demand curve" differently and that's one reason why, in an earlier chapter, we used the term "Pigou curve" instead for that relationship between the price level and the amount people want to buy. Thinking back a couple of chapters, we recall a problem with that idea. The problem is that the Pigou curve or "aggregate demand" in macroeconomics is nothing like the demand curve in microeconomics. In some ways it is the opposite. So, we might wonder, why should a relationship between the price level and the real GDP demanded work anything like a demand curve? For example, why would a relationship between the price level and real GDP demanded be downward sloping?

By the end of this chapter we will have an answer to that question.

An Alternative to Fiscal Policy