John Maynard Keynes, answered from the texts and cited to the page.
The question is broad enough to invite a survey, but the heart of it can be stated plainly: the classical economics, which England had inherited from Ricardo and which had governed respectable opinion for more than a century, rested on the proposition that supply creates its own demand.1 On that assumption, the aggregate demand price always accommodates itself to the aggregate supply price, whatever the level of employment — which is to say, effective demand has no unique equilibrium value but ranges across all values equally, and unemployment can only be voluntary or frictional.1
That is the doctrine I set out to overturn. The mechanism I put in its place runs as follows. Entrepreneurs fix the volume of employment at the level they expect will maximise the excess of proceeds over factor cost.2 The proceeds they expect to receive — the aggregate demand function — and the supply price of the output from employing any given number of men — the aggregate supply function — intersect at one point, and it is that intersection which determines employment.2
The value of demand at that intersection is what I call effective demand, and it is the governing quantity.2 Now, effective demand depends on two things: what the community will spend on consumption, and what it will devote to new investment.3 The first is governed by the propensity to consume; the second by the inducement to invest, which in turn depends on the relation between the marginal efficiency of capital and the rate of interest.4
Neither of these automatically produces full employment. There is no reason in general to expect the propensity to consume and the inducement to invest to stand in precisely the relationship that full employment requires — that is a special case, an optimum, realised only when current investment happens to fill exactly the gap between aggregate supply at full employment and what the community chooses to spend on consumption.5
It is not the normal case. The consequence is what I call the paradox of poverty in the midst of plenty.6 An insufficiency of effective demand will halt the expansion of employment before full employment is reached, even while the marginal product of labour still exceeds the marginal disutility of work.6 And the cruelty of it is that the richer the community, the wider the gap between actual and potential output tends to be — a wealthy community saves more, requires larger investment opportunities to absorb those savings, and is therefore more exposed to the failure of the inducement to invest.7
If that inducement is weak, the system does not correct itself; it contracts until it has become poor enough that the gap between saving and investment closes at a lower level of output altogether.8 Three gaps in existing knowledge had to be filled to make the argument complete: the analysis of the propensity to consume, the definition of the marginal efficiency of capital, and the theory of the rate of interest — and money plays an essential part in the last of these.9
That is the structure of the General Theory, and the theory of prices, far from being the centre of the analysis, falls out as a subsidiary matter once the rest is in place.9
The classical doctrine, on the other hand, which used to be expressed categorically in the statement that 'Supply creates its own Demand'... involves a special assumption as to the relationship between these two functions... the aggregate demand price (or proceeds) always accommodates itself to the aggregate supply price; so that, whatever the value of N may be, the proceeds D assume a value equal to the aggregate supply price Z which corresponds to N.The General Theory of Employment, Interest and Money, pp. 41–42
entrepreneurs will endeavour to fix the amount of employment at the level which they expect to maximise the excess of the proceeds over the factor cost... the volume of employment is given by the point of intersection between the aggregate demand function and the aggregate supply function... The value of D at the point of the aggregate demand function, where it is intersected by the aggregate supply function, will be called the effective demand.The General Theory of Employment, Interest and Money, pp. 41–42
The amount of labour N which the entrepreneurs decide to employ depends on the sum (D) of two quantities, namely D₁, the amount which the community is expected to spend on consumption, and D₂, the amount which it is expected to devote to new investment. D is what we have called above the effective demand.The General Theory of Employment, Interest and Money, pp. 44–45
The amount of current investment will depend, in turn, on what we shall call the inducement to invest; and the inducement to invest will be found to depend on the relation between the schedule of the marginal efficiency of capital and the complex of rates of interest on loans of various maturities and risks.The General Theory of Employment, Interest and Money, pp. 44–45
The effective demand associated with full employment is a special case, only realised when the propensity to consume and the inducement to invest stand in a particular relationship to one another... it can only exist when, by accident or design, current investment provides an amount of demand just equal to the excess of the aggregate supply price of the output resulting from full employment over what the community will choose to spend on consumption when it is fully employed.The General Theory of Employment, Interest and Money, pp. 44–45
This analysis supplies us with an explanation of the paradox of poverty in the midst of plenty. For the mere existence of an insufficiency of effective demand may, and often will, bring the increase of employment to a standstill before a level of full employment has been reached. The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment.The General Theory of Employment, Interest and Money, pp. 46–47
the richer the community, the wider will tend to be the gap between its actual and its potential production... a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members.The General Theory of Employment, Interest and Money, pp. 46–47
If in a potentially wealthy community the inducement to invest is weak, then, in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has become so poor that its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.The General Theory of Employment, Interest and Money, pp. 46–47
The analysis of the Propensity to Consume, the definition of the Marginal Efficiency of Capital and the theory of the Rate of Interest are the three main gaps in our existing knowledge which it will be necessary to fill... we shall find that the Theory of Prices falls into its proper place as a matter which is subsidiary to our general theory. We shall discover, however, that Money plays an essential part in our theory of the Rate of Interest.The General Theory of Employment, Interest and Money, pp. 47–48