Answer to Question #95513 in Macroeconomics for Maryum

Question

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

The main point of Keynes's theory is that the economy produces goods only if they can be sold. The investments have sense only if they are profitable, or it is expected that they will have high rate of return. So, expectations of future revenues motivate to expand the production, and they increase the investment demand. Government stabilization policies are implied for increasing spending (which is the component of aggregate demand) during recessions and decreasing spending during booms, to return aggregate demand to match potential output.