In, Aggregate Demand and Supply, a paper I wrote in 2006 that was published in the International Journal of Economic Theory, I developed my own version, and interpretation, of the Keynesian Cross. The Keynesian Cross is a diagram that, in times gone by, was taught to every student of macroeconomics.
The Keynesian Cross, a formulation of the central ideas in The General Theory, appeared as a central component of macroeconomic theory as it was taught by Samuelson in his textbook, Economics: An Introductory Analysis. The Keynesian Cross plots income on the horizontal axis and expenditure on the vertical axis.
In Figure 1, I have graphed a version of the Keynesian Cross that is closer in spirit to the General Theory than the version developed by Samuelson. In contrast to Samuelson’s version, my version plots employment on the horizontal axis and output, measured relative to the money wage, on the vertical axis.
Following Keynes, I am measuring employment in units of ordinary labor and I am measuring output in wage units. I explain this diagram in my published paper Aggregate Demand and Supply. The use of employment and output on the axes reflects the definitions in Chapter 4 of The General Theory. In his exposition of Keynesian Economics, Samuelson amended this diagram by plotting income on the horizontal axis and expenditure on the vertical axis.
The student who truly understands [the Keynesian Cross] is well on the way to mastering the most important ideas in macroeconomics. It illustrates the two most important concepts in The General Theory, concepts that have formed the basis for everything I have drawn attention to in my work.
The first is the idea of beliefs as an independent driver of business cycles. ... The second is ... that any unemployment rate can persist as a steady state equilibrium.
An important research question for macroeconomics is: what are the determinants of the aggregate demand curve and why does it shift around in sometimes unpredictable ways over time? In my view, Keynes’ theory of the consumption function is inadequate to answer this question. We should instead explicitly model the connections between consumption and wealth.
I have included my version of the Keynesian cross in a new paper I have just completed that explains the connection between ideas developed in my books and papers and those of economists who self-identify as Post-Keynesians. Look out for my new paper, Post-Keynesian Dynamic Stochastic General Equilibrium Theory, coming next week. A discussion of the Keynesian cross can also be found in my new book Prosperity for All, pages 156--158 and pages 174--175.