Answer to Question #95248 in Macroeconomics for komal

Question

4. Explain Keynes’s theory of how expectations affect investment demand. How is this theory related to Keynes’s view that aggregate demand would be unstable in the absence of government stabilization policies?

Answer 1

In Keynes' General Theory, investment determines effective demand, which determines unemployment and the labor market plays a negligible role. In New Keynesian models, labor market institutions determine the natural rate of unemployment and the speed at which unemployment adjusts to it (Sutherland, 2015). Investment is mostly ignored as a key variable behind the problem of high unemployment, despite a strong empirical association between investment and unemployment. This means that lack of government stabilization policies can cause aggregate demand to be unstable.

Reference

Sutherland, A. (2015). The world of economics in Keynes theory.