7 votes

I need help disproving Keynesian Theory

Everyone agrees with this:

  • Consumption is good
  • We cannot consume more than is produced, on net
  • To consume more requires us to produce more

The divide is on HOW to accomplish this. Two basic contradictory proposals:

  1. focus on increasing consumption which will "trigger" the needed production increase...or
  2. focus on increasing production to allow for the consumption increase

I think approach #1 is foolish. But I'm having a really hard time coming up with a simple, clear, concise, elegant explanation to show why it's foolish.

If you've heard such an explanation, or can come up with one, please let me know.

I think approach #1 is the single most dangerous and prominent misunderstanding of economics. Basically all future prosperity depends on debunking it...so no pressure.

EDIT: Thanks for all the feedback. Based on comments, I want to clarify something...

I'm not trying refute the fallacy that GOVERNMENT should decide for us what to consume. Yes, this is definitely a part of Keynesian Theory, but the broken window fallacy already does a nice job of refuting that part of the theory.

I'm saying that EVEN free people deciding on their own to increase their consumption on goods that really would make their lives better, does NOT stimulate the production increase required to meed those new demands.

In fact, those production increases come from the opposite of consumption: they require human work, innovation, technology, and under-consumption.

So whether or not the increased consumption is market driven or government driven, I don't think it causes production to increase, and I'm looking for a good way to show that.

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it is difficult to convince average Americans that Keynesianism doesn't work since it's what most Amercians have known the last 100 years. My dad didn't even know anything else but Keynesian economics existed since it has been the only kind of economics talked about for decades. In fact, my dad told me that money losing its value has been a fact since the beginning of time (which I know is wrong). It's hard to make the comparison between the two because it has been so long since we have had sound money.

Human stupidity, Expansion of the Universe & Debt are Infinite!

Albert Einstein was not certain about one of them.

Disclaimer: Mark Twain (1835-1910-To be continued) is unlicensed. His river pilot's license went delinquent in 1862. Caution advised. Daily Paul

Money does 3 things well 1)

Money does 3 things well

1) Act as a simple means of exchange.
2) Determine supply and demand.
3) Organize labor.

Expanding the role of money is like increasing the role of govt. Things get murkier and it allows for too many favours to be given to those in control.

Start with the broken window fallacy.

At any given time, there is a certain quantity of resources in the economy: labor, land, and capital. When one sector of the economy is "stimulated" resources are directed toward that sector and away from another sector: call this the "de-stimulated" sector. The "multiplier effect" emanating from the stimulated sector is counterbalanced by an inverse multiplier effect emanating from the de-stimulated sector.

For a simple illustration of this concept, see Chapter 2 of "Economics in One Lesson" by Henry Hazlitt.


However, it does not follow that the effect of stimulus "nets out" to zero, since not all economic activity is equal. On what basis can we compare the economic activity generated in the stimulated sector to the economic activity which has to be forgone in the de-stimulated sector?

The only rational means of comparing different enterprises is through profit-and-loss accounting. The more profitable enterprise is the preferable one, the one which is most conducive to the general prosperity. Public enterprises are, for well understood theoretical reasons, rarely if ever profitable at all, and certainly not as profitable as private enterprises. Likewise, government interventions in otherwise private enterprises tend to support the less profitable at the expense of more profitable competitors.

Keynesian stimulus invariably shifts resources from more profitable enterprises to less profitable enterprises, thereby wasting resources, and leaving society poorer than it would have been had those resources been directed by the market.

In the end, it's not about consumption versus production, neither is good or bad in itself. It's about who/what is directing resources in the economy: the market or the State. The Keynesians are in error because they believe that the general prosperity can be improved by having the State direct resources instead of the market - same as the socialists.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

I love the broken window fallacy

I think what I'm looking for is a broken window fallacy type story to debunk "consumption creating production".

Some other notes:

Creating additional production doesn't necessarily mean it was redirected away from production in another sector. Namely, this isn't necessarily true when the new labor for the new production was previously unemployed.

When the economy is at full employment (full production), the only way to increase production is to get better at production, right? This takes work, research, inventions, and technology. "Increasing consumption", even if by the market, can't do anything to increase production.

But what about when the economy is less than full employment? Then the claim of increasing consumption to get the unemployed working again becomes harder for me to refute. I still think it's inaccurate, but I'm having trouble expressing so.

One way to approach this...

...is to ask why there are ever idle factors of production in the first place.

The Keynesians attribute the business cycle to some murky force (e.g. "animal spirits") deep within the capitalist system - but this is just another way of saying they have no clue what causes the business cycle.

The Austrian explanation, on the other hand, is that artificially low interest rates encourage business expansion, which proves unprofitable when interest rates inevitably rise, and this precipitates bankruptcies and the bust phase. If this is correct, then the Keynesian "cure" for depressions is unnecessary, since we can prevent depressions from ever happening in the first place by preventing central banks from interfering in the credit markets.

But supposing there's already a depression underway, could the Keynesians be right that stimulus is necessary to put idle factors of production back to work? No, and here's why.

Every factor of production has what we call a marginal physical product: i.e. the additional quantity of product which its employment would yield. For example, suppose I can hire 1 additional labor-hour and thereby produce 4 additional widgets. The marginal physical product of that 1 labor-hour is thus 4 widgets. Multiply the marginal physical product by the sale-price of the product and you get marginal revenue product. Suppose widgets are selling for $3 each; then the marginal revenue product of that 1 labor-hour is $12. Thus, if I can hire 1 labor-hour for less than $12, I will, because I will make a profit doing so. If I can't get the labor-hour for less than $12, then I won't hire it, because in doing so I would take a loss. Very simple.

The only reason that a factor of production would be sitting idle is if it were priced above its marginal revenue product.

But in a free market, factors of production should never be sitting idle for any extended period of time. If a factor were sitting idle with no one wanting to buy it, its price would fall until it dropped below its marginal revenue product, at which point it could be profitably employed - and so it would draw buyers. Chronic underemployment of the factors of production is always a creature of government intervention in the market, not something which just occurs naturally in the free market.

So, to conclude, the best thing to do is to avoid depressions altogether by avoiding the credit expansions which cause them. The next best thing, if a depression occurs, is for the State to do nothing - or, better yet, to shrink and try to free the market as much as possible. Compare the Great Depression, where the State did everything imaginable, with the Depression of 1920, where the State did nothing and actually shrank. One lasted for over a decade, the other was so brief it's hardly known today.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

I think you're right

And I completely follow you.

But I also think someone like my mom (who totally followed and understood the broken window story when I told her) would be completely lost.

In her mind "many people are unemployed, and if we all bought more stuff we'd create the demand of goods and companies would then hire those unemployed people to meet those demands. Problem solved."

Claim that it was maldistribution of efforts and resources caused by the credit expansion due to artificially manipulated rates of interest that caused that unemployment in the first place, would pretty much sound like Chinese to her.

Yea, the ABCT might be beyond most people's level of interest

But I think most people intuitively understand the idea of the falling demand curve: lower prices for widgets means more widgets get sold.

If they ask you about all those empty homes sitting out there, and what should be done about it, I think they would understand if you explained that falling prices will clear the market - no need for any government intervention. However, this becomes difficult when it comes to labor. People might be fine with home prices falling, but they see falling wages as unacceptable. You can remind them that the alternative to lower wages is outright unemployment, but then they can respond by saying we should have make-work projects. And then to debunk that, you'd have to explain how profitability is the only criterion for the usefulness of some enterprise, and so make-work projects are counterproductive. But in saying this you might arouse their hatred of profit, which has been drilled into them through media and schooling - and now you've become in their eyes an apologist for the evil greedy capitalists. :-(

...plus, by this point in the conversation, they've probably lost interest anyway. Unfortunately, everything in economics relates to everything else, and if your interlocutor is persistent enough in his questioning, you have to practically explain all of economic theory to answer one little question, and most people don't care enough to hear it out.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."


That's why I think the best approach to explaining economics to most people is through historical examples, rather than pure theory.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."


Excellent post -- eloquent and concise.

And quite an education. Bookmarked. Thank you.

"Bipartisan: both parties acting in concert to put both of their hands in your pocket."-Rothbard

Consumption is a tricky thing in this debate

For example who is doing the consuming?

public or private sector?

How is the consumption paid for? Saved capital or on credit expansion?

Without this info we are left to guess and cannot make any sound arguments for or against.

Obviously if consumption is done by the private sector using saved capital, thereby creating a larger demand and increased production, all is well.

No so much the other way. That is the disagreement or IMO fallacy of Keynesian thought. They don't care where the consumption comes from, the ends justfy the means. Austrians believe increased "artifical" consumption (ie gov spending) will create bubbles.

I think you just highlighted exactly what I think is foolish...

I don't even think private consumption "creates a larger demand and increases production".

Private consumption is fine, in that we need to consume some stuff to make life good, but that consumption comes at the EXPENSE of growing production, not causing or stimulating production.

It is precisely when people DON'T consume that they save and invest in future production (and therefore future consumption).

I don't agree with your first

I don't agree with your first statement that consumption is good.

"and the truth shall make you free"
John 8:32

ggb is right

'Consumption is good' is a crappy statement because it implies non-consumption (ie, saving) is not good. The proper way to state that proposition is, perhaps, 'want satisfaction is good'.

First, understand the basics of capital theory. In a really condensed nutshell, there is more than one way to produce a good. There is always a way to increase quality or quantity of production by extending the length/period of production. Extending the production process requires saving.

Production of consumer goods should match demand, which will automatically take into account savings. To say 'consumption is good' or 'saving is good' misses the relationship between the two. If consumption and saving are determined by individual preference, things don't go haywire. If you try to stimulate one side or the other you are looking at the disaster we're in now.

consumption is the essence of

consumption is the essence of living, or staying alive.

Consumption is the ultimate purpose of all economic activity.

We save and produce only because that will eventually yield us more consumption, not because we like saving and producing for their own sake. I think that's all the OP meant.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Yes, this is what I meant

That the goal is to consume goods, and this consumption of goods is what makes life better.

In a word, the ability to consume more is prosperity.

Obviously, there's a whole debate about whether we should consume now or save so we can consume more in the future...but consumption is the ultimate goal.