The 'principle' of effective demand: Pasinetti's view
Luigi Pasinetti points out that, though '"The Principle of Effective Demand" is the title of a crucial chapter - Chapter 3 - of Keynes's General Theory, [...] the "principle" of effective demand is not studied' (Pasinetti, 1997, p. 93).
According to Pasinetti, what is worth denoting as the 'principle' should belong to a more fundamental level of investigation which concerns a basic characteristic of a production economy, independently of any behavioural relations, of market structure and even of any institutions.
It is generally recognized that Keynes's theory of effective demand, which focuses on the physical quantity-adjustment mechanism and operates through the multiplier process, is based on aggregate behavioural functions - that is, aggregate demand functions and aggregate supply functions.
In order to specify the basic characteristics of a 'monetary production economy', Pasinetti decides to abandon all those behavioural functions.
Above all, the replacement of a 45° line for the original aggregate supply function [Z =
is required. Thus, he states:
It meant abandoning a level of analysis that was aimed at explaining the actual behaviour of entrepreneurs acting in a specific market structure (imperfect or perfect competition) in order to uncover more fundamental relationships. It meant giving up the details of firms' behaviour in order to gain deeper insight into the more basic— institutionally free—characteristics of the economic system.
(Pasinetti, 1997, p. 98)
On the other hand, when considering the demand side, Pasinetti leaves aside Keynes's consumption and investment functions. Thus, one may deprive the usual 45° line diagram of every behavioural content, therefore 'remaining simply with the two axes and the 45° line' (Pasinetti, 1997, p. 99).13
What is behind such a modified diagram is that
at any given point in time a production economy is characterized by a specific and well-differentiated productive capacity and by a corresponding labour force (with specific skills and training) [...] The productive capacity and labour force are whatever they are: in the short run they cannot be changed. But they only represent potential production. Actual production will thus turn out to be whatever effective demand is expected to be. In this sense, effective demand generates production.
(Pasinetti, 1997, p. 99)
Very interestingly, Pasinetti adds the following:
This process (of production-generation by effective demand) is a basic characteristic of any production economy. It is quite independent of any behavioural relations and thus of any particular adaptation mechanism. It is independent of market structure, it is even independent of the particular consumption and investment functions introduced by Keynes. Basically, it is independent of institutions, by simply being inherently characteristic of the way in which industrial economy (in contrast with agricultural and artisan economy) have come to be set up.
It is this basic, non-institutional, or if we like pre-institutional, characteristic, lying at the very foundations of industrial societies, that - I should venture to say - represents the 'principle' of effective demand.
(Pasinetti, 1997, p. 100)
Mitsuharu Ito clearly makes the same point but from a different perspective:
The production price of Sraffa represents the exchange-ratio of commodities to make possible the circular process of the system as a whole, quite independently of any behaviour of economic agents. In this sense, the characteristic of Sraffa's theory is 'objective' and is different from the ordinary price theory based on a specific behaviour of economic agents. Thus, Sraffa's theory may be comparable with Keynes's macrolaw formalized in the Multiplier mechanism operating entirely independently of the behaviour of individual economic agents.
(Ito, 1987, pp. 154-5)
At any rate I think it is hardly necessary to point out that the principle of effective demand explicitly analysed by Pasinetti is not based on the atomic hypothesis. This is because the hypothesis always requires the specific behavioural assumption of the atomic unit, whereas the 'principle' is thoroughly independent of all behavioural relations.
It is not unreasonable to say that even the theory of effective demand formalized by Keynes would be totally unsuitable for the atomic hypothesis. For the multiplier mechanism depends on genuine behavioural functions, but the multiplier process as such would proceed on its own whatever line of action the individual units prefer.