John Maynard Keynes 1883 - 1946.
Professional economist, wide ranging intellect, charismatic, develops practical policy solutions, influence through Treasury position and UK delegation to Bretton Woods, post-war Labour party intellectual underpinning, House of Lords, theories permeate to common acceptance throughout the political spectrum during the 1950's and 1960's in the UK and internationally. Indian Currency and Finance 1913 is an early work based on his experience in colonial office and containing an exposition of the gold-exchange standard. In Economic Consequences of the Peace 1919 he gains world-wide recognition as a political economist, a humanitarian, and pro-peace. Tract on Monetary Reform early statement of early economic theory, aims at stabilising business activity. Treatise on Money 1930, specialised and innovative analysis, defines profit inflation and income inflation. Later these concepts evolve into cost-push inflation (increased wages lead to higher prices, thus demands for higher wages) and demand-pull inflation (increased demand leads to higher prices, thus higher revenues to factors of production, thus higher demand).

General Theory of Employment Interest and Money 1936 is his masterpiece, definitive summation and embodiment into single theory of earlier principles. Aims at defining determinants of the overall amount of wealth generated in an economy, contrasts with earlier classical attempts to define the distribution of the amount of wealth that is generated. Keynes regards the classical school as stretching from Ricardo, Mill, Marshall through to Pigou. He questions the assumption of the classical school (stated most explicitly in Say's law) that the economy naturally achieves full employment of available resources. The classical analysis assumes that equilibrium cannot be achieved at any point other than full employment, thus classical analysis does not apply itself to situations in which under-employment occurs. Keynes wished to provide policy prescriptions to alleviate the occasional tendency for under-employment of resources to occur. He denies Smith's assertion that 'what is prudent conduct in the master of the family can scarce be folly in that of a great Kingdom', and establishes the classification of macro-economic (aggregate economy wide balances addressed by early classicists) and micro-economic (mid 19th Century onwards analysis of equilibrium at the level of the firm and individual).

Keynes's General Theory is based on Malthusian concept of effective demand. Keynes adapts effective demand and defines it as 'the aggregate income which the entrepreneurs expect to receive inclusive of the incomes which they will hand on to the other factors of production, from the amount of current employment which they decide to give'. The effective demand curve intersects with the supply function (itself relating the aggregate supply price of output at varying levels of employment). This point is the equilibrium employment level since it shows profit maximisation. Thus the equilibrium point is expressed in terms of effective demand for goods in monetary terms. Attention then turns to the factors which determine what the equilibrium level of demand is. To answer this question, Keynes establishes a set of functional relationships. Demand for goods in monetary terms must be the same as money income because payments and receipts for the total of economic transactions must be the same. In other words national income equals national expenditure. Employment thus depends on the size of the national income.

Keynes argues that attention should focus upon what determines the size of the national income. In order to do this, he develops a formal relationship between income and expenditure, showing the impact of expenditure on current consumption and saving. He defines the propensity to consume as the relationship between aggregate consumption and total income, and says that the propensity to consume drops as income rises. He thus defines the 'marginal propensity to consume'. Now, total income must equal total expenditure, and total expenditure equals expenditure on current consumption plus investment. Thus:
Y (total income) = C (current consumption) + I (investment).

Since the level of employment depends upon the level of income, we can say that level of employment depends upon level of consumption plus investment. If investment reduces, income will fall. If income falls, consumption will fall by an amount determined by the marginal propensity to consume. Thus income will again fall to a new equilibrium point. There is a whole series of levels of income at which this equilibrium may occur, thus a whole series of equilibrium employment levels. The level of investment will determine the equilibrium level of employment. (Over employment is not possible because such will lead to inflation thus reducing real value of income. But Keynes does not elaborate here.) Also money wages are inflexible downwards, thus classical equilibrium models are held to be inaccurate.

The 'expectation' of the future yield from assets and 'liquidity' are two concepts now introduced into the analysis.

The marginal efficiency of capital (MEC) is the prospective (thus expectations vitally important here) revenue from investing an extra unit of invested capital, i.e. the yield on investment. The highest industry-wide MEC defines the general marginal efficiency of capital. MEC is related to the amount invested, since as investment increases high yielding opportunities are taken up leaving less profitable projects available, and vice versa as investment falls. Keynes believes in a long run tendency for MEC to fall. The MEC schedule is also known as the investment demand schedule, and shows the relationship between the amount invested and the MEC.

The liquidity principle is introduced to show the impact of individuals' attitude to the holding of money. Money is an asset for which the liquidity premium is always in excess of the carrying costs. Peoples' desire to hold money, now termed liquidity preference, becomes central to the theory of interest. Keynes rejects the view that the rate of interest is determined by time preference in the long run. He also rejects the view that the rate of interest is determined by supply and demand of funds in the short run, since he holds that saving must equal investment in each period This can be seen because:
Saving (S) = Income (Y) less consumption (C)
so,
S = Y - C, and since Y = C + I, then S = I.
Furthermore, since classical theory holds that the intersection of saving and investment schedules determine the rate of interest, then a change in demand for funds (investment) or a change in the supply of funds (saving) changes the rate of interest. But such changes in the supply and demand for funds cannot change without an impact upon income, unless they change together in a precise manner. Instead Keynes holds that rate of interest is a reward for foregoing liquidity. Thus quantity of money and liquidity preference determines the rate of interest. So Keynes develops his theory of interest as a monetary phenomenon. (Critics of Keynes say that the rate of interest is not independent of the level of income).

The MEC varies with confidence levels, among other factors, thus investment can rise or fall over time. The multiplier effect (first proposed by R. F. Kahn in The Relation of Investment to Unemployment in the Economic Journal 1931), determines the effect that a given change in investment will have upon aggregate income. The change in aggregate income will equal the change in investment multiplied by the 'multiplier'. The multiplier equals:
1/(1 - marginal propensity to consume)
But, as a society grows wealthier, the marginal propensity to consume falls and hence the multiplier will fall. And since the MEC falls as a society becomes wealthier (in other words as profitable opportunities are eaten away), there will be a continual trend toward lower investment at any given rate of interest. However, investment will continue to the point at which the MEC equals the rate of interest. Since liquidity preference and quantity of money determine rate of interest, then falls in the rate of interest should encourage greater investment. But Keynes says that the rate of interest will not fall fast enough to maintain investment at a level that determines full employment. This is because of the liquidity trap.

In the liquidity trap, the government cannot cause the rate of interest to fall by increasing the quantity of money after a certain point because, at this point, liquidity preference becomes infinite and economic agents hold on to all the new money created instead of investing it. (This feature occurs because when interest rates fall sufficiently low, investors will expect that the tendency is for the next move in interest rates to be upwards. Since investment asset prices fall as interest rates go higher, individuals will not want to buy highly priced securities. They will therefore not invest their money into them.)

Keynes also identifies an accelerator effect, being the effect upon investment of a change in consumption.