Comparing the Original 1933, IS-LM (LP) Model of Keynes With the Advanced Version of February, 1936 Contained in Chapter 21 of the General Theory

Abstract

Keynes’s original IS-LM (LP) model of 1933, although a major conceptual breakthrough, was technically and mathematically flawed because Keynes incorporated realized and expected variables in the same set of equations.

Keynes had solved this problem by early 1936 by formulating a completely new model that David Champernowne and Brian Reddaway had never seen or heard of before in Keynes’s lectures between 1933 and 1935 – the D-Z model of chapters 20 and 21. Keynes provided a brief introduction, outline and summary of the D-Z model on pages 24-32 of chapter 3 of the General Theory. The D-Z model focused exclusively on expectations and uncertainty. The IS-LM (LP) model focused exclusively on the realized, actual outcomes taking place in the economy in the Goods and Money sectors. The labor market, production function, marginal optimizing conditions and theory of the firm, with uncertainty and profit expectations integrated into the formal model, was done within the framework of the D-Z model in chapters 20 and 21. Both Kahn and Joan Robinson had no inkling about what was transpiring in chapters 20 and 21 of the General Theory.

Keynes’s final IS-LM(LP) model represents a major improvement over Keynes’s first exposition of his IS-LM model in December, 1933. Keynes’s consumption function, C, has an explicit marginal propensity to consume incorporated and investment multiplier defined. The variable, Y, is explicitly incorporated into the LM (LP) equation,M=L, as M=L(Y,r).