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The following passage appears in the first chapter of The General Theory. Explain in your own words what Keynes means when he argues that the classical theory is a special case. Why are there multiple equilibria in Keynes’s system? What are the ‘facts of experience’ to which he is referring?
I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.
The classical macroeconomic theory is a model that is based on the concept of self-regulating capacity of the economy. The model states that government intervention is not necessary in the stabilisation of an economy and the economy in itself is capable of regulating itself. This is based on the idea of a laissez fare system of an economy. The classical doctrine states that the economy is always at or near the natural level of real GDP. It has the base on the Say’s law and the belief that the price, wage and the interest rate are flexible in an economy. Thus, it believes that the economy is always capable of achieving the natural level of real GDP or output when the economic resources are fully employed. According to the Say’s law, when an economy produces a certain level of GDP, it also would also generate the income needed to purchase that level of GDP.
Keynes has always been keen to point out the errors of the classical theory at all the times. Keynes has always referred to this theory as being a ‘special case’ which is being applicable to the broadly unchanging economy that is operating under full employment. The mainstream Keynesian’s also believes that the Keynesian theory is also a short run case of the classical analysis. The ‘special case’ refers to the fact that the achievement of natural level of real GDP as suggested by the classical economists is practically impossible in most of the cases and thus fits in to some special cases only. There is no guarantee in the economy that all the income that is being accumulated would be spent as suggested by the economists in achieving this fact. Some of this income would be saved and thus would not form a part of the consumption expenditure of the economy which all relates to this special case.Multiple equilibria would refer to the fact that there are multiple solutions to a single problem in economic model analysis. The Keynesian economic model always would refer to the impact of aggregate demand in an economic analysis. According to the Keynesian view, the aggregate demand would not always be equal to the productive capacity of the economy. The aggregate supply curve of Keynesian model depicts the concept of multiple equilibria. The Keynesian theory defines uncertainty as an inverse function of the weight of evidence. The relation that is being suggested between savings and investment is yet another criteria that would help in the explanation of the formation of multiple equilibria in Keynesian economics
In the given paragraph, Keynesian theory suggests about the facts of experience as the various practical situations that are evident as stated in the above paragraph. It states that it is practically not possible to have a situation of the economy approaching a real GDP measure due to the existing of savings in the economy. Moreover, the investment patterns in the economy would also remain the reason for the same. Thus, all the above factors would contribute to the ‘facts of experience’ as suggested under the Keynesian model.