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Microeconomics: John Maynard Keynes
John Maynard Keynes is one of the major economic theorists recognized for his major contribution to economics. Due to his contribution, Keynes was rated as the most dominant economist in the twentieth century (Stein 132). Keynes theories were adopted by many governments for their attempt to correct economic problems their economies were facing.
Keynes main contribution was advocating for interventionist government policy. He suggested that the government should use monetary and fiscal measures in order to deal and solve the harmful effects of economic booms, depressions and recessions. Implementation of his argument had a major impact on microeconomics.
According to Keynes, amount devoted to investment is determined by the rates of interest and rate of return on capital (Keynes 98). If interest rates fall savings are reduced, then there is little incentive to hold deposits in bank. This reduces the investment level since the amount saved is the same as the amount spend on investment. Effect on microeconomic is the reduction of production as investment reduces.
Marginal efficiency of capital can be termed as the expected rate of return. This involves the expected future profits. Moreover, if marginal efficiency of capital is high, potential investors will be encouraged to invest in the opportunity in question.
Keynes argued that it is important for the government to get involved in determination of the interest rate in order to dictate the economic levels of the country and each sector with an aim of realizing the expected goals.
His contribution affected the microeconomics in quite a significance way. To start with, influences in the investment means that the aggregate supply of various sectors in the economy are altered with (Fletcher 157). If the measures taken by the government are meant to increase production of a given sector, then demand must be raised as well. Therefore, the surplus from the sector must be taken absorbed in the economy. If there is no specific demand, then the government will have to buy the surplus commodity in order to maintain prices.
Increasing the supply of commodities will have impact on the prices of the commodity in question, because reduction in prices is necessary in order to be able to offset the excess supply. Lowering prices will raise the aggregate demand for the commodity.
Increasing the investment levels raises the household’s wages thus raising their purchasing power. This will mean that they will be able to raise their demand. When demand goes up, the prices of commodity goes up too. These imbalances go on until equilibrium is established in the market, in case there are no price ceiling and price floors.
Keynes argued that where marginal efficiency of capital is encouraging; investors will venture in the opportunities available thereby, raising the supply of commodities. Raising supply will force the prices to fall and when they fall, consequently, demand will also fall.
Keynes argued that the government should undertake the fiscal and monetary methods to try and maintain the interest at the most favourable levels. Interest dictates the level of savings and as a result, investment too.
After the depletion period when the economy is experiencing hardships, the interest rates are low, and investment is not encouraged. At this time, Keynes suggested that the government should come up with away to raise interest levels in order to attract investors as well as come with other ways to encourage investments such as giving subsidies and reducing taxes. This will have an impact on the microeconomic sector as prices of commodities will be varied. Supply will increase as well as the demand.
During the boom period the economy is likely to be experiencing inflation, there is a lot of money to the disposal of households and firms. At this juncture, Keynes suggested that the government should come with mechanism to encourage savings and reduce the money in circulation (Fletcher 107). This act will diminish the money, lower demand and supply as well. The microeconomics sector is thus influenced by these government activities as advocated by Keynes, because of tempering with the forces of demand and supply.
Keynes argued that during hard times in the economy the government should come in and get involved in deficit spending with intentions to stimulate the activities, which are going on in the economy. This is also known as giving subsidies to the producers and waiving taxes on producers. The impact on the microeconomic is that prices are altered by exogenous factors beside the market forces.
Keynes suggested that during depression time in the economy, the government should adopt measures in order to help to solve the problem of low investment levels. He suggested involvement of monetary measures where the government may find it necessary to instruct the central bank to print more money in order to avail funds for the investment. This is one of the deflationary measures.
Keynes advocated for the government to engage open market operations. This would entail buying and selling of treasury bills and bonds. In case the government realizes that there are high levels of inflation, it will sell these bonds with an aim of reducing the money circulating in the economy (Stein 162). This will have an impact on the microeconomics in that, the households purchasing power is lowered, firms cannot expand. Production will be lowered to levels that the government find reasonable.
Interest rate valuation as recommended by Keynes affects the levels of output in the economy. When output are lowered in cases where the government decreases the interest rates, furthermore, investment will be reduced and consequently the output level. This will affect the amount of exports negatively and thereby, the employment opportunities will be foregone. The impact will be to lower the purchasing power of individuals (Keynes 85). On the other hand, the reduction in output level will reduce supply in the economy thereby raising the prices of the commodities.
Keynes argued that during recessions the aggregate demand in the economy usually falls. Low spending power continues causing the demand to fall and thus the vicious circle of job losses. He suggested that the solution to this problem would be to borrow money and boost demand by availing money to the economy. This will affect the microeconomic sector in that the demand and the prices will also rise.
According to Keynes, it is not obvious that full employment would be achieved by making wages sufficiently low. He further argued that unemployment usually arises when people do not spend enough money. He suggested that in order to correct this, money in circulation should be raised. The effect of this in the micro economy is that the purchasing power will be raised and the prices will go up encouraging more production thus more supply of the commodity in the economy.
Keynes stated that in case investment exceeds savings, inflation will arise. Whenever savings exceed investment recession is experienced (Keynes 132). To correct this, Keynes suggested that spending should be encouraged and at the same time discourage savings. This affects microeconomic, therefore, demand increases raising the prices and consequently supply. This movement of the market forces continues until equilibrium is attained.
Use of printing money to correct deficits in the economy as suggested by Keynes is likely to cause inflation (Stein 119). When this happens, the general prices of products will rise since there will be a lot of money chasing few goods. Supply will rise since the increased prices will encourage more production.
In conclusion, it is evident that Keynes is a theorist who has contributed greatly to the economics. His work was affected by most government with an attempt to correct their economic problems that they were facing. He highlighted that, though the forces of demand and supply should be allowed to determine prices and the production levels, the economic situations called for an intervening hand of government to ensure that the economic activities are carried out in line with the expected plans. He prescribed for use of both monetary and fiscal policies in order to solve the challenges arising in the economy, which affects the microeconomic activities. Varying the interest rates, printing of more notes and operating market operation were some of the monetary policies that he suggested. He also proposed subsidies, taxes and government purchasing as examples of fiscal policies that should be used to regulate the economic activities going on in the economy. Keynes suggestion had a major impact on the microeconomics, because it involved varying prices of the products thus interfering with the forces of demand and supply as the sole determinants of levels of supply, demand and prices.
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