228 Economic Theory: An Introductionerable. Keynes died of a heart attack in 1946 and was honored in
services at Westminster Abbey.
John Maynard Keynes wrote his great epic, espousing “eco
nomic interventionism,” at a time when American and most of
the free world was experiencing a prolonged depression. In it he
questioned some of the past assumptions of those he called
“classical” economists, who claimed that capitalism had a natu
ral mechanism which would maintain conditions of full employ
ment and production. This assumption, which Keynes attacked,
was based on Say’s Law, which states that “supply creates its
own demand.” The classical economists believed that if busi
nessmen increased production or supply, there would naturally
be an accompanying rise in wages paid. The recipients of these
wages would spend, and the spending would result in an increase
of consumption or demand. Thus, the economy would always be
balanced at the maximum level of supply and demand, which is
the maximum level of production and employment.
Say’s law is founded on three basic assumptions. First, a
worker’s wage equals the value of the product of his labor. If this
is were not so, then an increase in supply would not produce an
equal increase in demand. The second assumption is that wages
and prices are flexible. Thus, as prices rise so do wages, and vice
versa. This must be true, or else supply and demand would not
be in equilibrium at the full employment level. Finally, if a
person is unemployed it is either temporary or by his own choice.
Since, if supply is at a maximum (as Say’s Law presupposes),
then all willing workers must be employed.
Keynes disputes these contentions by way of a practical
illustration. What if prices were to rise and wages were to remain
constant? The classical economist claims that workers would cut
production or demand higher wages so that their wages would
equal the value of the products of their labor. Keynes maintains
that, in reality, the workers continue to work at the same wages.
The employer, reaping higher profits, expands production by
hiring more workers at the same wage. Thus, wages do not equal
the value of the product of the labor—wages are not flexible—
they do not rise with prices. Furthermore, unemployment must
not be temporary or voluntary, since additional workers are
easily obtained. Keynes then proceeds to explain the nature of
involuntary unemployment, that which classical economists
claim cannot exist.