J M Keynes's Aggregate Supply Function, Z, is Simply Pigou's Aggregate Supply Function with Price and Profit Expectations Substituted for Realized Prices and Actual Economic Profit

Abstract

In September, 1933, Pigou’s The Theory of Unemployment appeared. After reading it, Keynes decided that he would not continue to use his own original, simultaneous, four equation, IS-LM model because he could not satisfactorily integrate price and profit expectations into the IS portion of the model. Keynes’s model of an Aggregate Demand Function, D, and an Aggregate Supply Function, Z, is a generalized version of Pigou’s very similar aggregated Real Demand function as a whole analysis in The Theory of Unemployment. Keynes improved on the mathematical modeling by explicitly integrating expected profits and expected prices into D and Z. Integrating expectations led to multiple D-Z combinations that represent multiple equilibria. The locus of all such multiple equilibria forms the major theoretical breakthrough of the General Theory, Keynes’s Aggregate Supply Curve. Pigou had no Aggregate Supply Curve since he had only one D curve intersecting with one Z curve. Unemployment for Pigou had to be a disequilibrium while for Keynes it was an equilibrium. Pigou’s contributions to Keynes’s General Theory have not been sufficiently recognized except for contributions by Brady (1994) in the 20th century and by Arthmar and Brady (2009) in the 21st century. Both Keynes and Pigou made a very simple adjustment to the standard Profit =TR-TC model. That simple and straightforward adjustment was to add TC to Profit. Since TC equals TVC in the short run when the capital stock is held fixed, the aggregate supply function or price is TC plus Profit=TR. Letting P= profit, wN equaling TVC, and pO equaling TR, one ends up with the aggregate supply function, Z, equals wN plus P. The aggregate demand function is pO equals D. Therefore, D=Z states that pO=wN plus P. Keynes’s innovation was to reinterpret p to be an expected price and P to be an expected profit. This allowed him to construct an ASC curve of multiple equilibria, only one of which is full employment. This simple conclusion has still not been grasped by the editors, associate editors, and referees of the Cambridge Journal of Economics as well as many others.