Narrator: What happens when an entire economic system breaks down? In the 1930s, the world was plunged into the Great Depression. Millions were unemployed, factories were silent, and families were destitute. The prevailing economic wisdom of the time, known as classical economics, offered a cold comfort: the market would eventually correct itself. It insisted that wages would fall, businesses would start hiring again, and prosperity would return. But as the crisis deepened, it became painfully clear that the market was not self-correcting. A devastating paradox had emerged: poverty in the midst of plenty. It was in this environment of global crisis that economist John Maynard Keynes published his revolutionary 1936 work, The General Theory of Employment, Interest and Money. This book didn't just offer a new policy; it presented a fundamentally new way of understanding how economies actually work, arguing that the classical view was dangerously flawed and applicable only to a special, and rare, set of circumstances.

Narrator: Keynes begins by dismantling the core assumptions of the economic theory that had dominated for over a century. Classical economics, he argues, was primarily concerned with how resources are allocated, not with what determines the total volume of employment. This is a point illustrated by the historical focus of classical thinkers like David Ricardo. In the early 19th century, Ricardo famously argued that the principal problem of political economy was not determining the causes of overall wealth, but understanding how that wealth was divided among landlords, workers, and capitalists.

This focus led to a critical blind spot. The classical model rested on two main postulates: first, that a worker's wage is equal to the value of what they produce, and second, that workers will only accept a wage that compensates them for the "disutility" of working. According to this logic, the only types of unemployment that could exist were "frictional," meaning temporary mismatches in the job market, or "voluntary," where workers simply refused to accept a wage they felt was too low. The theory had no room for the concept of large-scale involuntary unemployment—the very situation plaguing the world during the Great Depression, where millions were desperate for work at any prevailing wage but could find none. The classical school assumed that if workers would just accept lower money-wages, their real wages would fall, and businesses would hire them. Keynes argued this was a fundamental misunderstanding of how a modern economy functions.

Narrator: The classical school’s great error, according to Keynes, was its unquestioning belief in Say's Law, the idea that "supply creates its own demand." The theory held that the very act of producing goods generates enough income to purchase those goods, making a general glut or a deficiency of demand impossible. Keynes turns this idea on its head. He introduces his central concept: the Principle of Effective Demand.

In Keynes's framework, the level of employment is not determined by wage bargains, but by the point where aggregate supply meets aggregate demand. Entrepreneurs hire workers based on the expected proceeds from the sale of their output. The aggregate supply function represents the total revenue businesses must expect to receive to justify employing a certain number of people. The aggregate demand function represents the actual revenue they do expect to receive. The equilibrium level of employment is found at the intersection of these two curves—the point of "effective demand."

Crucially, Keynes argues there is no guarantee this equilibrium point will correspond to full employment. This is because of a fundamental psychological law: as a community's income rises, its consumption also rises, but not by as much. This creates a gap between total income and consumption spending. For the economy to sustain that level of employment, this gap must be filled by investment. If investment is insufficient to fill the gap, effective demand will be too low, and the economy will settle into an equilibrium with high unemployment. This insight explained the paradox of the Depression: an economy could get stuck in a low-output, high-unemployment trap simply because there wasn't enough overall spending.

Narrator: To understand why demand might be deficient, Keynes delves into the "propensity to consume." He identifies a range of objective and subjective factors that influence how much people spend out of their income. Objective factors include changes in wages, interest rates, and fiscal policy. Subjective factors are psychological, including motives like precaution, foresight, pride, and even avarice, which lead individuals and institutions to save rather than spend.

However, the most important concept he introduces here is the marginal propensity to consume—the portion of each extra dollar of income that is spent. Because this is always less than one (people save some of their extra income), it gives rise to the "multiplier" effect. When there is an increase in investment—for example, the government building a new dam—it creates income for construction workers. These workers then spend a portion of that new income, which becomes income for shopkeepers. The shopkeepers, in turn, spend a portion of their new income, and so on. The initial act of investment is thus multiplied throughout the economy, leading to a much larger total increase in national income and employment. The size of this multiplier is determined by the propensity to consume. A higher propensity to consume means a larger multiplier, making investment a powerful tool for stimulating a sluggish economy.

Narrator: If investment is the key to filling the gap between income and consumption, what determines the level of investment? Keynes argues it depends on the relationship between the rate of interest and what he calls the "marginal efficiency of capital." The marginal efficiency of capital is simply the expected rate of return on a new investment. A business will invest as long as this expected return is higher than the interest rate it has to pay on borrowed funds.

The problem, Keynes notes, is that these expectations about the future are incredibly precarious and based on flimsy knowledge. Long-term investment decisions are not, and cannot be, the result of precise mathematical calculation. Instead, they are driven by what he famously termed "animal spirits"—a spontaneous urge to action rather than inaction. This optimism is the real engine of enterprise.

This makes the investment market highly volatile. Professional investors, Keynes observed, are often not concerned with the genuine long-term yield of an asset. To illustrate this, he used the analogy of a newspaper beauty contest, where the goal is not to pick the face you find prettiest, but to pick the face that you think other people will find prettiest. Similarly, investors on the stock market are often engaged in a game of anticipating what average opinion expects average opinion to be. This focus on short-term sentiment and liquidity makes investment prone to sudden and violent collapses of confidence, which can plunge an economy into a slump.

Narrator: The classical theory taught that the rate of interest was the price of saving—it was the mechanism that balanced the supply of savings with the demand for investment. Keynes argues this is completely wrong. The decision to save is separate from the decision of how to hold those savings. Once a person has saved, they must decide whether to hold that wealth in a liquid form, like cash, or in an illiquid asset, like a bond.

The rate of interest, in Keynes's view, is not the reward for saving, but the reward for parting with liquidity. It is the price that equilibrates the public's desire to hold cash (liquidity preference) with the available quantity of money. People desire liquidity for three main reasons: the transactions-motive (for daily purchases), the precautionary-motive (for emergencies), and the speculative-motive (to profit from future changes in interest rates). It is this theory of liquidity preference, combined with the quantity of money set by the central bank, that determines the rate of interest, which in turn influences the level of investment.

Narrator: The logical conclusion of Keynes's entire theory is that modern capitalist economies are not self-regulating systems that automatically tend toward full employment. The volatility of investment driven by "animal spirits," combined with a propensity to consume that leaves a gap in demand, means that the economy can easily get stuck in a prolonged slump. A flexible wage policy is not the solution and can even make things worse by increasing the burden of debt and creating business uncertainty.

Therefore, Keynes concludes that the duty of managing the overall volume of investment cannot be safely left in private hands. He argues for a "socialization of investment," where the state takes on a greater responsibility for organizing investment to close the gap between savings and consumption. This does not mean state ownership of the means of production, but rather a partnership where public authorities use fiscal policy (government spending and taxation) and monetary policy to ensure that aggregate demand is sufficient to maintain full employment. This was a radical departure from the laissez-faire orthodoxy, providing the intellectual foundation for a much larger role for government in managing the economy.

Narrator: The single most important takeaway from The General Theory is that the level of employment in a modern economy is determined by the level of aggregate demand, which is inherently insufficient to guarantee full employment on its own. The classical belief in self-correcting markets was a dangerous illusion that left societies helpless in the face of economic collapse. Keynes provided both a diagnosis and a cure, arguing that since the system would not fix itself, it was the responsibility of the government to intervene and manage demand.

This book fundamentally and permanently changed the landscape of economic thought and government policy. While many of its specific prescriptions remain the subject of debate, its central idea—that governments can and should act to mitigate the destructive cycles of boom and bust—became the new orthodoxy for nearly half a century. It challenges us to abandon the comforting but false idea of a perfectly rational, self-regulating market and instead confront the messy, psychological, and unstable reality of the economy we actually live in.