The General Theory
by John Maynard Keynes (1936)
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[p.35]
BOOK II
DEFINITIONS AND IDEAS
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[p.37]
Chapter 4
THE CHOICE OF UNITS
I
In this and the next three chapters we shall be occupied with an attempt to clear up certain perplexities which have no peculiar or exclusive relevance to the problems which it is our special purpose to examine. Thus these chapters are in the nature of a digression, which will prevent us for a time from pursuing our main theme. Their subject-matter is only discussed here because it does not happen to have been already treated elsewhere in a way which I find adequate to the needs of my own particular enquiry.
The three perplexities which most impeded my progress in
writing this book, so that I could not express myself
conveniently until I had found some solution for them, are:
firstly, the choice of the units of quantity appropriate to the
problems of the economic system as a whole; secondly, the part
played by expectation in economic analysis; and, thirdly, the
definition of income.
II
That the units, in terms of which economists commonly work, are unsatisfactory can be illustrated by the concepts of the National Dividend, the stock of real capital and the general price-level: --
(i) The National Dividend, as defined by Marshall [p.38] and Professor Pigou, [1] measures the volume of current output or real income and not the value of output or money-income. [2] Furthermore, it depends, in some sense, on net output;¾on the net addition, that is to say, to the resources of the community available for consumption or for retention as capital stock, due to the economic activities and sacrifices of the current period, after allowing for the wastage of the stock of real capital existing at the commencement of the period. On this basis an attempt is made to erect a quantitative science. But it is a grave objection to this definition for such a purpose that the community's output of goods and services is a non-homogeneous complex which cannot be measured, strictly speaking, except in certain special cases, as for example when all the items of one output are included in the same proportions in another output.
(ii) The difficulty is even greater when, in order to calculate net output, we try to measure the net addition to capital equipment; for we have to find some basis for a quantitative comparison between the new items of equipment produced during the period and the old items which have perished by wastage. In order to arrive at the net National Dividend, Professor Pigou [3] deducts such obsolescence, etc., "as may fairly be called 'normal'; and the practical test of normality is that the depletion is sufficiently regular to be foreseen, if not in detail, at least in the large". But, since this deduction is not a deduction in terms of money, he is involved in assuming that there can be a change in physical quantity, although there has been no physical [p.39] change; i.e. he is covertly introducing changes in value. Moreover, he is unable to devise any satisfactory formula [1] to evaluate new equipment against old when, owing to changes in technique, the two are not identical. I believe that the concept at which Professor Pigou is aiming is the right and appropriate concept for economic analysis. But, until a satisfactory system of units has been adopted, its precise definition is an impossible task. The problem of comparing one real output with another and of then calculating net output by setting off new items of equipment against the wastage of old items presents conundrums which permit, one can confidently say, of no solution.
(iii) Thirdly, the well-known, but unavoidable, element of vagueness which admittedly attends the concept of the general price-level makes this term very unsatisfactory for the purposes of a causal analysis, which ought to be exact.
Nevertheless these difficulties are rightly regarded as "conundrums". They are "purely theoretical" in the sense that they never perplex, or indeed enter in any way into, business decisions and have no relevance to the causal sequence of economic events, which are clear-cut and determinate in spite of the quantitative indeterminacy of these concepts. It is natural, therefore, to conclude that they not only lack precision but are unnecessary. Obviously our quantitative analysis must be expressed without using any quantitatively vague expressions. And, indeed, as soon as one makes the attempt, it becomes clear, as I hope to show, that one can get on much better without them.
The fact that two incommensurable collections of miscellaneous
objects cannot in themselves provide the material for a
quantitative analysis need not, of course, prevent us from making
approximate statistical comparisons, depending on some broad
element of judgment rather than of strict calculation, which may [p.40] possess significance and validity within certain limits.
But the proper place for such things as net real output and
the general level of prices lies within the field of historical
and statistical description, and their purpose should be to
satisfy historical or social curiosity, a purpose for which
perfect precision¾such as our causal
analysis requires, whether or not our knowledge of the actual
values of the relevant quantities is complete or exact¾is neither usual nor necessary. To say
that net output to-day is greater, but the price-level lower,
than ten years ago or one year ago, is a proposition of a similar
character to the statement that Queen Victoria was a better queen
but not a happier woman than Queen Elizabeth¾a
proposition not without meaning and not without interest, but
unsuitable as material for the differential calculus. Our
precision will be a mock precision if we try to use such partly
vague and non-quantitative concepts as the basis of a
quantitative analysis.
III
On every particular occasion, let it be remembered, an entrepreneur is concerned with decisions as to the scale on which to work a given capital equipment; and when we say that the expectation of an increased demand, i.e. a raising of the aggregate demand function, will lead to an increase in aggregate output, we really mean that the firms, which own the capital equipment, will be induced to associate with it a greater aggregate employment of labour. In the case of an individual firm or industry producing a homogeneous product we can speak legitimately, if we wish, of increases or decreases of output. But when we are aggregating the activities of all firms, we cannot speak accurately except in terms of quantities of employment applied to a given equipment. The concepts of output as a whole and its price-level are not required in this context, since we have no need of an absolute [p.41] measure of current aggregate output, such as would enable us to compare its amount with the amount which would result from the association of a different capital equipment with a different quantity of employment. When, for purposes of description or rough comparison, we wish to speak of an increase of output, we must rely on the general presumption that the amount of employment associated with a given capital equipment will be a satisfactory index of the amount of resultant output;¾the two being presumed to increase and decrease together, though not in a definite numerical proportion.
In dealing with the theory of employment I propose, therefore, to make use of only two fundamental units of quantity, namely, quantities of money-value and quantities of employment. The first of these is strictly homogeneous, and the second can be made so. For, in so far as different grades and kinds of labour and salaried assistance enjoy a more or less fixed relative remuneration, the quantity of employment can be sufficiently defined for our purpose by taking an hour's employment of ordinary labour as our unit and weighting an hour's employment of special labour in proportion to its remuneration; i.e. an hour of special labour remunerated at double ordinary rates will count as two units. We shall call the unit in which the quantity of employment is measured the labour-unit; and the money-wage of a labour-unit we shall call the wage-unit.[1] Thus, if E is the wages (and salaries) bill, W the wage-unit, and N the quantity of employment, E = N ·W.
This assumption of homogeneity in the supply of labour is not upset by the obvious fact of great differences in the specialised skill of individual workers and in their suitability for different occupations. For, [p.42] if the remuneration of the workers is proportional to their efficiency, the differences are dealt with by our having regarded individuals as contributing to the supply of labour in proportion to their remuneration; whilst if, as output increases, a given firm has to bring in labour which is less and less efficient for its special purposes per wage-unit paid to it, this is merely one factor among others leading to a diminishing return from the capital equipment in terms of output as more labour is employed on it. We subsume, so to speak, the non-homogeneity of equally remunerated labour units in the equipment, which we regard as less and less adapted to employ the available labour units as output increases, instead of regarding the available labour units as less and less adapted to use a homogeneous capital equipment. Thus if there is no surplus of specialised or practised labour and the use of less suitable labour involves a higher labour cost per unit of output, this means that the rate at which the return from the equipment diminishes as employment increases is more rapid than it would be if there were such a surplus.[1] Even in the limiting case where different labour units were so highly specialised as to be altogether incapable of being substituted for one another, there is no awkwardness; for this merely means that the elasticity of supply of output from a particular type of capital equipment falls suddenly to zero when all the available labour specialised to its use is already employed. [2] Thus our assumption of a homo-[p.43]geneous unit of labour involves no difficulties unless there is great instability in the relative remuneration of different labour-units; and even this difficulty can be dealt with, if it arises, by supposing a rapid liability to change in the supply of labour and the shape of the aggregate supply function.
It is my belief that much unnecessary perplexity can be
avoided if we limit ourselves strictly to the two units, money
and labour, when we are dealing with the behaviour of the
economic system as a whole; reserving the use of units of
particular outputs and equipments to the occasions when we are
analysing the output of individual firms or industries in
isolation; and the use of vague concepts, such as the quantity of
output as a whole, the quantity of capital equipment as a whole
and the general level of prices, to the occasions when we are
attempting some historical comparison which is within certain
(perhaps fairly wide) limits avowedly unprecise and approximate. [p.44]
It follows that we shall measure changes in current output by
reference to the number of hours of labour paid for (whether to
satisfy consumers or to produce fresh capital equipment) on the
existing capital equipment, hours of skilled labour being
weighted in proportion to their remuneration. We have no need of
a quantitative comparison between this output and the output
which would result from associating a different set of workers
with a different capital equipment. To predict how entrepreneurs
possessing a given equipment will respond to a shift in the
aggregate demand function it is not necessary to know how the
quantity of the resulting output, the standard of life and the
general level of prices would compare with what they were at a
different date or in another country.
IV
It is easily shown that the conditions of supply, such as are usually expressed in terms of the supply curve, and the elasticity of supply relating output to price, can be handled in terms of our two chosen units by means of the aggregate supply function, without reference to quantities of output, whether we are concerned with a particular firm or industry or with economic activity as a whole. For the aggregate supply function for a given firm (and similarly for a given industry or for industry as a whole) is given by
Zr = fr(Nr),
where Zr is the proceeds (net of user
cost) the expectation of which will induce a level of employment Nr.
If, therefore, the relation between employment and output is such
that an employment Nr results in an
output Or, where Or = yr(Nr),
it follows that
Zr + Ur(Nr) fr(Nr) + Ur(Nr)
p = ¾¾¾¾¾¾¾ = ¾¾¾¾¾¾¾¾¾
Or yr(Nr)
is the ordinary supply curve, where Ur(Nr) is the (ex-[p.45]pected) user cost corresponding to a level of employment Nr.
Thus in the case of each homogeneous commodity, for which Or = yr(Nr) has a definite meaning, we can evaluate Zr = fr(Nr) in the ordinary way; but we can then aggregate the Nr's in a way in which we cannot aggregate the Or's, since SOr is not a numerical quantity. Moreover, if we can assume that, in a given environment, a given aggregate employment will be distributed in a unique way between different industries, so that Nr is a function of N, further simplifications are possible.
Footnotes:
[p. 38] 1 - Vide Pigou, Economics of Welfare, passim, and particularly Part I., chap. iii. [back to text]
[p. 38] 2 - Though, as a convenient compromise, the real income, which is take to constitute the National Dividend, is usually limited to those goods and services which can be bought for money. [back to text]
[p. 38] 3 - Economics of Welfare, Part I. chap. v., on "What is meant by maintaining Capital intact"; as amended by a recent article in the Economic Journal, June 1935, p.225. [back to text]
[p. 39] 1 - Cf. Prof. Hayek's criticisms, Economica, Aug. 1935, p.247. [back to text]
[p. 41] 1 - If X stands for any quantity measure in terms of money, it will often be convenient to write Xw for the same quantity measured in terms of the wage-unit. [back to text]
[p.42] 1 - This is the main reason why the supply price of output rises with increasing demand even when there is still a surplus of equipment identical in type with the equipment in use. If we suppose that the surplus supply of labour forms a pool equally available to all entrepreneurs and that labour employed for a given purpose is rewarded, in part at least, per unit of effort and not with strict regard to its efficiency in the its actual particular employment (which is in most cases the realistic assumption to make), the diminishing efficiency of the labour employed is an outstanding example of rising supply price with increasing output, not due to internal diseconomies. [back to text]
[p.42] 2 - How the supply curve in ordinary use is supposed to deal with the above difficulty I cannot say, since those who use this curve have not made their assumptions very clear. Probably they are assuming that labour [p.43] employed for a given purpose is always rewarded with strict regard to its efficiency for that purpose. But this is unrealistic. Perhaps the essential reason for treating the varying efficiency of labour as though it belonged to the equipment lies in the fact that the increasing surpluses, which emerge as output is increased, accrue in practice mainly to the owners of the equipment and not to the more efficient workers (though these may get an advantage through being employed more regularly and by receiving earlier promotion); that is to say, men of differing efficiency working at the same job are seldom paid at rates closely proportional to their efficiencies. Where, however, increased pay for higher efficiency occurs, and in so far as it occurs, my method takes account of it; since in calculating the number of labour units employed, the individual workers are weighted in proportion to their remuneration. On my assumptions interesting complications obviously arise where we are dealing with particular supply curves since their shape will depend on the demand for suitable labour in other directions. To ignore these complications would, as I have said, be unrealistic. But we need not consider them when we are dealing with employment as a whole, provided we assume that a given volume of effective demands has a particular distribution of this demand between different products uniquely associated with it. It may be, however, that this would not hold good irrespective of the particular cause of the change in demand. E.g. an increase in effective demand due to an increased propensity to consume might find itself faced by a different aggregate supply function from that which would face an equal increase in demand due to an increased inducement to invest. All this, however, belongs to the detailed analysis of the general ideas here set forth, which it is no part of my immediate purpose to pursue. [back to text]
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