But people do not in fact spend all they earn. Already, Alfred Marshall, Keynes teacher at Cambridge, had written in a critique of John Stuart Mill’s version of the supposed law that supply creates its own demand: “But though men have the power to purchase, they may not choose to use it.” (4) For Keynes, “…when our income increases, our consumption increases also, but not by so much. The key to our practical problems is to be found in this psychological law. …. This analysis provides 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.” (5)

Because of the psychological law, as Keynes called it, that people prefer not to spend all they earn, there will always be a certain amount of savings, except perhaps in the extreme case where everybody is living from paycheck to paycheck This is a good thing if you want there to be funds available for investment. It is a good thing if you want people to postpone consumption and put their money in banks, and stocks, and bonds, and insurance, and corporate retained earnings, and government budget surpluses etc. in order to bring into play what Ludwig von Mises called “round about methods of production.” Savings make possible a world where instead of living from hand to mouth people can enjoy the benefits of incomparably more efficient round about production methods, which can only be enjoyed after long lead times needed for research and development and/or long lead times needed for the installation of expensive equipment, such as, for example, dams, hydroelectric generators, long distance transmission lines, and the wiring for electricity of all the buildings in all the neighborhoods of a large city.

 

But the inevitability of savings is not necessarily a good thing from the point of view of the accounting identity noted above. If business equals production for profit, and production for profit depends on sales, and every sale is somebody else’s purchase, then it is not clear how business is supposed to continue from one time period to another. If all the money spent is all the revenue, and if some of the revenue is set aside for savings, then there will be less money spent the next time around. And therefore less revenue.