On Keynes's Theory of the Aggregate Price Level in the Treatise: Any Help for Modern Aggregate Analysis?

Abstract

The paper explores the theory of the aggregate price and profit in Keynes's Treatise for its implications for modern macroeconomic analysis. Here profits are defined in terms of aggregate investment and saving. Deriving aggregate total revenue and aggregate total cost from this price theory, the paper shows how to construct a version of the Keynesian cross diagram. It then examines an IS-LM model from the perspective of the Treatise's price theory, focusing on an interpretation of the business cycle in which savings and investment may not equal. Comparing the Treatise's price theory with a neoclassical definition of profit, the paper reconstructs the cross diagram and reconsiders a related IS-LM model, with a focus on fiscal policy. This clarifies how microfoundations affect the standard cross and IS model. Further, the reconstructed cross diagram allows for derivation of neoclassical aggregate supply, to which the derivation of neoclassical aggregate demand can be added. Comparative statics of this AS-AD analysis suggests that a focus on profit might be useful in identifying the manifestation of exogenous technology shocks of real business cycle theory.