 So the topic this time is Keynes and Hayek head-to-head and I can tell you that I've read Keynes's general theory more times than I want to think about. And each time though, I figure out a lot a little more because it's hard to decipher him. So we'll see how this goes. Let me just start from the by telling you so you know what's coming is that I'm going to build the Keynesian macro vision and in such a way that it will allow us to morph into the Austrian view. And then you'll see that the little steps you take to make it morph are totally acceptable. Nobody could dispute about it. So anyhow, let's see how it goes. So this is the application of capital-based macroeconomics, despite that it's mostly about Keynes at least in the start. Keynes and Hayek says head-to-head. And it's easier to do than you would think. Here we go. So I contrast here the visions and frameworks of these two economists. And it goes like this. Keynes's vision of the economy suggests a circular flow framework in which earning and spending are brought into balance by changes in the level of employment. Okay, that's got to stick with you. Changes in employment is what causes things to change, not change in prices or interest rates or anything like that. Hayek's vision of the economy suggests a means ends framework. In which the means of production are transformed over time into consumable output. So let's do, I'll probably apologize for this. We're going to do a brief review of the Keynesian circular flow framework, although mine looks a little different than some of the others. So we'll see. Circular flow framework. Here you have business organizations represented up top. That's just a shell of a thing. There's nobody up there. And down below are workers, consumers, investors. All right. This is the basis for the circular flow. And so let's get it started. There's one flow. All right. And it says labor and other factor services. Well, what are other factor services? Well, among other things, they're investors. But Keynes gives short shrift to that, at least in this particular way of doing things. All right. And then we have an alternate flow the other way around for income. So everybody that earns income gets that income somehow or other. So that's half of the story, as you can see, we need the other half. And here it goes. So what we have here is goods and services. So that's the flow of goods and services around the economy. And of course, that's offset by expenditures, consumption and investment expenditures. That's the way it works. Okay. Now, you don't know if you can see that pretty well. Federal Reserve Policy, and it's got interest rates there. It looks pretty slow. Let's get it started. There's the circular flow. Okay. It is still pretty slow, but no wonder it's it's set at six percent. That's pretty high. Go around here to two percent. We can really get some more flowing out of it. Okay. So that's the mindset, I think, of the Keynesians. Okay. Well, let me stop it. That's the circular flow and there's Keynes. And there's Hayek. And Hayek, of course, doesn't do circular flow. He does the triangle. Okay. Stages of production, consumer goods. It can change too, but in ways that are very sensitive to the interest rates. So with the change in interest rate here, you get a change in the in the triangle. And that part of it is totally out of Keynes. You never see it that way. Okay. So in Keynesian equilibrium, income equals expenditures. That's that's just means that the loop around the right side and the loop around the left side have the same quantity. Okay. Of goods on one hand and expenditures on the other and so on. And what I'm going to do now is do this like the principal's macro does it and put this income. You see where income is here. Income is going to be on the horizontal axis and expenditures on the vertical axis. And if these two things go together, as far as the magnitude, then it turns out that equilibrium means the 45 degree line. Once we get to the Y equals E point, let's see, Y equals C plus I have left out G just to keep it from getting too too much. Okay. So there's expenditures on the vertical axis and income on the horizontal axis. And we can put a 45 degree line there to say that the economy, according to Keynes, can be in an equilibrium at any point on that line. Okay. Being in equilibrium in the sense that income equals expenditures. It may be equal income equal expenditures at full employment or it might be income equal expenditures at well below full employment or it can be income equal expenditures at rising price level. Okay. So we'll see how this works. The economy is in Keynesian equilibrium somewhere along the 45 degree line, the line itself identifying all possible income expenditure equilibrium points. Okay. Now there's a consumption equation which says as taught at all levels in academia, the consumption function is an essential component of the Keynesian framework that presumes stability of this function underlies Keynesian thinking. That's sort of the rock as far as he's concerned. Everything else is kind of loose. And there's a consumption equation A plus BY. A means that vertical intercept down there which means that even if you're not earning any income, any income, you do some spending if only out of funds that you do have. Can't last for long but that's that's the way it works. And the B of course is the slope of the consumption function B over 1 it shows there. And that's pretty much it for the consumption function. It doesn't move around much. Okay. Now there's investment is actually C plus I so investment is what it is and it's measured by the distance between consumption and C plus I. All right. So that thing can change in the up direction or in the down direction and change a lot or change a little. That's sort of the monkey in the in the story. It jumps around quite a little bit. All right. So consumption and investment as well as government spending, we don't have it in here. Our portrayed as additive components of total spending. The three components are distinguished largely in terms of their stability characteristics. So stable and that's consumption. Unstable that's investment. You may not like to hear the next step. Stabilizing that's government. Really? We'll see. Okay. So now we're that C plus I intersects here. We've got a holy private economy. And so no government involved right now. And so that's an equilibrium. And the way I'm going to start out though is to say that if if only by circumstance only by happenstance, that turns out to be full employment. So there's income there on the horizontal axis. How much income people are making. There's consumption and there's investment. And that triangle is an equilateral triangle. So income equals consumption plus investment. That's that's the equilibrium set. That's what that's what we mean by equilibrium in Keynesianism. Okay. Now holy private economy achieves an income expenditure equilibrium when y equals C plus I note that income and expenditures themselves rather than prices, wages and interest rates are the equilibrating variables. Okay. According to Keynes, it is only by accident or design that the economy is actually performing at its full employment potential. And I've had students ask, well, what else is there between accident and design? Well, it's a fully functioning market economy where prices move when they need to move and interest rates move without being disturbed by the central bank and so on. So only by accident or design. And now just we're going to assume that initially full employment conditions prevail. So I'm, you know, I'm giving a lot to Keynes right now, but it's only happenstance that that's true. And so I can put, you know, okay. Now I've got the graphs here on the right that we use for the Austrian view. And here it puts consumption on the vertical axis and investment on the horizontal axis. We're going to have a playoff here between these two different diagrams. And in that diagram, of course, we show the PPF, the production possibilities frontier. All right. Now, the way I've shown it, just by happenstance, the thing is on the frontier. So we're really not only at Keynesian equilibrium, but we're at full employment Keynesian equilibrium. And that's shown by being on the frontier. In capital based macroeconomics, full employment implies that the economy is operating on its production possibilities frontier, the PPF itself being defined in terms of sustainable output levels of consumption and investment goods. All right, we've got that. Now, there's the labor market, supply and demand for output there, and W's wage in what means what, the number of workers, something like that. And the supply and demand has that in equilibrium, too. So I'm being as kind to Keynes as I can. All right. In Keynesian macroeconomics, full employment implies that the labor market clears at the going wage rate, that's a phrase that Keynes uses over and over, the going wage rate. How did it get going? Not quite sure, but the going wage rate clears the market. The going wage rate itself having emerged during a period in which the economy was experiencing no macroeconomic problems. That's the story. Now, labor income, that's Y equals W times N. We can show that in that box down there, W times N, that's total employment income, is fully representative of total income. So if you figure out what total income is and how it moves, then you assume that everything else moves together. So changes in labor income stand in direct proportion to changes in total income. Well, that doesn't quite work, but that's Keynes. That's really just sort of a hidden conclusion. You get that after reading Keynes, but you didn't actually hear it saying anywhere along the line. All right. Let's go on. All right. Now, there's that circular flow again. There's Y sub FE. FE stands for iron in chemistry, but it means full employment income with full employment. According to Keynes, a collapse of investment activity, the collapse of being attributed to a waning of animal spirits is the primary cause of economic downturns. That's Keynes. That's hardcore Keynes. In response to reduced investment and hence reduced employment opportunities, the economy spirals downward into depression and possibly into deep depression. So we'll watch that and see how it goes. Oh, there's the animal spirit. All right. That's gone. Okay. So now the investment has dropped dramatically. And if you look at the at the circle up here, you get E now is less than Y. All right. And so it's out of equilibrium. And you can see that that little vertical thing up there. That's excess inventories. And okay. Now, see, the economy has fallen down to the new equilibrium and still called it an equilibrium. It's just not a full employment equilibrium. And you get E equals Y now. So we get a shift, a downward shift by a delta I is how much investment has fallen. And because of that income has fallen. And you see income has moved further than investment. That's what the multipliers are all about. So Y equals one over one minus B times I. That's the geometry. That's what you get at when you do the geometry. Consumption has fallen. Not the consumption function. It doesn't fall. But we moved along. And so fewer consumption goods are being bought. Okay. Now, the simple investment spending multiplier one over one minus B quantifies the relative rates of the downward or upward spiraling. It can be upward spiraling, even at full employment. And then you get inflation. All right. Now get this. Here's the labor market. And we note that the going wage keeps going because the adjustment was made in terms of everything falling, even after the market conditions that gave rise to it are gone. So we're stuck with this high rate. And Keynes actually said, well, we need to be stuck with it because that's where we need to be once we get it fixed. And once you fix it, you got the wage rate back where it was still there because it hasn't fallen in you. Now, I think I'm going to skip a segment here. Yeah. All I did with what I'm skipping is showing how it could fall again and get worse and so on. So we know that. So when I say morphing from circular flow to mains ends, that's, that's what our major accomplishment is going to be. And so we start once again with what we had C plus I and consumption function, not shifting. The nature of the Keynesian style spiraling, spiraling associated with recession, depression and inflation becomes more apparent with the production possibilities frontier and play. Keynes doesn't put it in play, but we do. And let me show you how to do that. Also, the PPF helps build a bridge from Keynes to Hayek. Well, there's the PPF. And right now we're at full employment and we see that with the PPF were on the on the frontier. So all as well, at least for the time being, all right. All right. And there again is the labor market. Okay. And now what I'm going to do is let this thing fall again. And you've already seen what happens with the C plus I plus D and all that. And so you can focus on what happens with the production possibilities frontier. So let's see how this goes. The waning of animal spirits causes investment to decrease and with it, income and consumption. The economy falls inside the PPF. So watch the PPF. There it goes. Okay. So that's the story now. And you see that Keynesian diagram just like it was before. But now we look at the PPF diagram and we see what kind of a mess we're in. We're in the frontier. It didn't go along the frontier. It goes along going into the innards of the frontier. And I'll do more of this. Let's see. There they are supplying demand for labor and but with no wage change. Okay. A further waning sends the economy deeper into the PPF interior. Let's watch that. Again, here it is. Okay. Same thing with the wage situation. Wage rate is still what it was initially. So there's a lot of unemployment. Now look at this PPF and you see the movement that's being made and we can trace that out with our own line here. So I show movements can be along those dots. And if it's beyond the frontier, it's just inflation that's going on. And inside the frontier, of course, it's unemployment is the problem. So the straight line that passes through these points and the geography gets it going that way is in the Keynesian demand constraint. I call it the Keynesian demand constraint. I've only heard of one other economist using that constraint. There's one of my nephews was studying in Yale and his professor drew that line to show something like this. I didn't see the rest of it. All right. Note that if investment were to fall to zero, the economy would settle into an income expenditure equilibrium with Y equals C. And actually I put that in there. You'll see a little less the vertical intercept of the Keynesian demand constraint is aligned with the intersection of the consumption function in the 45 degree line. So you can see it along there. And that's just a way of showing you I've got my ducks lined up. It all fits together. Did that for my own sake, really, that burdening you about it. And I show some algebra here and I'm going to skip over that, not make you do the algebra. I don't know if you can see it from there anyhow, but see there's an equation with those two equations with three unknowns and you could manipulate to get rid of any one of the unknowns and have one equation with the two that you didn't get rid of. And if you do that the right way, do your algebra the right way, keeps going there, but I've got to it. So what it shows for one thing is that that vertical distance up there is A over 1 minus B and it shows that the slope is B over 1 minus B. And as a result of that, you get this equation. You get C equals A over 1 minus B plus B over 1 minus B times investment. If you understand what B is, it's something less than 1, isn't it? And so it means both of those magnitudes up there are positive, which means in effect that C and I move up and down together. They don't move across the PPF. And because of that then, let's see, now I am going to skip some of this because this is Keynes' own math to do the same thing. And he comes to the conclusion though, he says this formula is not of course quite as simple as this illustration, but there's always a formula more or less of this kind relating to the output of consumption goods in which it pays to produce the output of investment goods. This conclusion appears to me to be quite beyond dispute, yet the consequences which follow are from it or at the same time unfamiliar in the greatest possible importance. Now what makes it important? I don't think it's important because the whole thing was derived by the assumption that wages and prices don't change, but only changes in the labor happens. Now you might notice the change I've made here and showed the PPF not as solid but as dashed. If the economy has to move up and down that blue line, then the PPF is not doing anything for you. You can't move along the production possibilities frontier, so the possibilities should be the PF, not the PPF. That second P means possibility. It's not possible to move along the frontier. It moves along this demand constraint, so-called. Okay, now let's go. To keep track of possible interest rate movements, the loanable funds market can be brought into view. We can do this. I've got a story about it. That's just the wage rate and vertical axis savings and investment like that. That's saving and that's investment. And it's a supply and demand curve. And so that shows you what the interest rate is and it shows you how much savings and investment there is over and above what's shown already on the PPF. Though Keynes argued that neither saving nor investment dependent to any significant extent on the interest rate, he also argued that both curves, as conventionally drawn, like I've drawn them, shift together, leaving the interest rate unchanged. So this is why I didn't pay attention to the interest rate. If those two curves always shift together and by the same amount, then the interest rate doesn't change. And that's what caused him to just eliminate the interest rate from consideration. With the loanable funds market in play, we see that decreased investment is accompanied by a leftward shift in the demand for loanable funds putting downward pressure on interest rates. All right. Let me show that shift. There it is. Demand shifts. It looks like it caused the interest rate to go down, doesn't it? But that doesn't happen according to Keynes because with the spiraling downward of income implies that the supply of loanable funds, aka savings, also shift leftward, relieving the downward pressure on interest rates. And watch that. And so now you've got both curves shifting and each to an extent that keeps the interest rates out of play. And he was happy about that. He just didn't have to even bother about interest rates. Now appearing in Keynes general theory is this specific application of the loanable funds framework. The implications according to Keynes is that the loanable funds reckoning is at best superfluous. And here, once I had drawn this diagram here, I realized that that was the diagram in Keynes, except we'll have to kind of fix it up. I mean, get the general theory up there. There it is. And I could tell you that that's the one and only diagram in the entire general theory. That's it. And it's only there because one of his colleagues told him that you better put this in. You better put this in because nobody will think you're doing what you're doing unless you do that. You've got to have it. Now, you look at that, you think, well, that looks a little different than what I had. But we could show that that's not the case either. If you look at it, you see R on the horizontal axis, which really means rate of interest, I guess it's interest. And look what's on the vertical axis. Nothing. So that's kind of a slip there. But if you look at the, let's see, as shown on page 180 of this general theory, Keynes presented the loanable funds market with the interest rate R on the horizontal axis. Although he failed to label the vertical axis, the accompanying text indicates that saving and investment are measured vertically. And I show those down there, you probably can't read it. So savings and investment. Keynes diagram can be flipped over and rotated 90 degrees to make it conform with modern renditions of the market for loanable funds. Let's do that. There they are. And that some of the savings curve are intended only to demonstrate that income is a shift parameter. So I'll eliminate those. And then there's the diagram that tells the story. What you see is if you get a shift in the demand for loanable funds, you'll get another shift to such an extent that it keeps the interest rate from falling or rising. So that's what he got out of this. I know a lot of people who have read the general theory never quite understood what in the world that was about, that one graph was about. And I have to admit I didn't know what it was about either until I had done my own on the PowerPoint. And then it occurred to me that that's what that's what Keynes was doing. That's exactly what he was doing. Okay. You can see it on the other side too. You can do it either way except I just liked it better when you can see it like that. Now the one thing that's wrong, of course, is that he had his curvature on the supply side backwards. He just goofed about that, you know, nothing to say about that. And so look at that diagram again. It's the exact same thing. Keynes also denied that an increase in saving would have the effect imagined by the loanable funds theorists. Keynes' paradox of thrift is articulated by the general theory is to the point, every attempt to save more by reducing consumption will so effect incomes that the attempt necessarily defeats itself. In other words, everything slides downward. If you save more, everything goes downward and the economy crashes. The rightward shift in the supply of loanable funds puts downward pressure on the interest rates. But before there can be any movement along the demand for loanable funds, the pressure is relieved as reduced consumption causes income and hence savings to fall. Everything falls. So there you get the shift. Hence the paradox of thrift. Try to save more and you'll still earn less. I mean that was what Keynes came up with. And once again, the labor market still has that same so-called going wage. It's pretty bad. To resolve Keynes' paradox of thrift requires only that we replace Keynesian cross which reflects the economy's circular flow with a Hayekin triangle which depicts means and ends in their temporal sequence. So now here is where I'm going to start doing the morphing and show you what happens if we bring the triangle out. The level of consumption that appears as part of the Keynesian circular flow. There it is. There's consumption. Also appears in the capital based framework as a consumable output of a temporarily sequence production activities. Here we can just bring that Hayekin triangle in. So instead of just using c and c plus i or c plus i plus g, we're going to use the Hayekin triangle. And now we'll watch what happens. Keynes however assumes fixed structure of industry. That occurs several times in the general theory. Like, you know, we want to figure out what's going on but let's assume there's a fixed structure of industry so it won't be too complicated I guess. Fixed structure of industry which in the current context implies a Hayekin triangle of fixed shape. The only live issue being the triangle of size which represents the level of employment in the extent of capital utilization. Okay, now let's see what we're going to do. We begin as before with the economy functioning at its full employment level. All right, we'll do that. The labor market is represented, there it is, by one supply and demand graph. Okay, so we don't have that problem. The market mechanisms in play here are still those envisioned as Keynes. So we're still doing Keynesian stuff but we're doing it with the triangle as Keynes supposedly would imagine it. And it goes like this in accordance with the paradox, an increase in saving causes the economy to spiral downwards to the less than full employment level. Okay, let's watch it. And you see with the with the triangle it doesn't change its shape it just change its magnitude. And all the stuff between the new one and the old one is unemployment. Okay, that's the story as Keynes would have it. And we're still using just one labor graph and we've got unemployment as you can see in that diagram. Note that the sole effect of the structure of production comes from the initial reduction in consumption. The derived demand effect works undemandaged on all the earlier stages. The interest rate is effectively out of play. The leftward shift of savings looks took the downward pressure off the interest rates. And in any case the capital structure is assumed to be fixed. So it's just a bollock step totally dysfunctional system. Now three modifications are needed to transform the Keynesian vision to the Hayekian vision. And think about this. Can any of these three be a problem? Okay, let's see how it works. What's one? Divide the structure of production into stages. Okay, that's good enough. Got stages two. Allow the stage specific labor markets in which wage rates adjust to change market conditions. You'd like to see that. Okay. And there they are. And then there's one more. What is it? Let's see. Oh, get rid of the Keynesian demand constraint because now that you have wage rates changing differentially and you have the triangle changing differentially, that's what moves it along the front. So somehow we've got to get rid of that demand constraint. Watch. Gone. And so now the paradox of thrift becomes the gateway to growth a little hyperbole but we can do it. With wage rates and interest rates both adjusting to change market conditions the economy can move along the PPF and the structure of production can adjust to an increase in saving. So we watch this. Mr. Keynes' aggregates conceal the most fundamental mechanisms of change. It's high. And there you have it. Okay. Thank you.