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KEYNESIAN

THEORY OF
EMPLOYMENT
I. INTRODUCTION
 Book titled “ General theory of
Employment, Interest and Money”.
 He believed Full employment was a rare
phenomenon / special case, unlike –
Classical economics.
 Keynes believed in Less than full
employment
II. PRINCIPLE OF EFFECTIVE DEMAND
 Volume of employment depends on level of effective
employment.
 Therefore, unemployment = Less demand
 Effective demand = Total demand of goods and services
 Therefore, Income and Flow of expenditure are important
considerations.
 Income Expenditure Demand
 Higher income = high expenditure = Low investment
 But expenditure and investment will have to be equal
 If the above does not happen a gap / deficiency is formed.
 A gap is formed between income and consumption which
will lead to unemployment.
 Hence, it must be understood that Consumption and
Investment also have to be given equal importance.
 Keynes failed to assume or consider Government
interventions.
 He was more concerned with the entrepreneurs and
capitalistic environment.
 But today business environment is “Mixed”.
 Hence, Effective demand = C + I = G
 C = Consumption expenditure of Household
 I = Investment expenditure of Private firm
 G = Government expenditure on Consumption and
Investment goods
III. LEVEL OF EFFECTIVE DEMAND
 According to Keynes, Effective demand = Interaction between
Aggregate Supply function and Aggregate Demand function
Aggregate Supply Function ( ASF )
- It is the selling Price at which seller is willing to supply his
goods and services at the market.
Price increases as Quantity increases.
Whole Output = Response of all entrepreneurs = Level of
Labour
Level of Output = Level of Employment
- FOP / COP = Factor Of Production / Cost Of Production
Land, Labour, Machinery and Investment.
AGGREGATE SUPPLY FUNCTION / AGGREGATE
SUPPLY PRICE SCHEDULE
 Minimum price of the revenue proceeds the entrepreneurs must get from the sale
of output, associated at different levels of employment.

Level of Money wages Aggregate


Employment supply Price
( ASF) ( N x W)
1 10 10
2 10 20
3 10 30
4 10 40
5 10 50
Y
Rs. ASF
MINIMUM RECEIPTS /

50

40

30
INCOME

20

10
Q

O 1 2 3 4 5

EMPLOYMENT (N) IN LAKHS


 X axis represents the level of employment and the Y axis
represents minimum sales.
 ASF is an upward sloping curve.
 ASF is the relationship between employment N and marginal
productivity ( MP )should be traced.
 ASF curve : is possible only when
- The money price of all outputs and inputs are
constant
- When prices are constant and community’s total
expenditure, which is measured at these constant
prices and the level of employment and income
change in same proportion.
- That is if total expenditure is increased employment
and income will increase.
AGGREGATE DEMAND FUNCTION
 Maximum sale proceeds which
entrepreneurial community actually does
expect to be received from sale of
different qualities of output leading to
different levels of employment.
 Increase in level of employment, the
aggregate demand price tends to rise
 Maximum sale expected from given output
depends on total expenditure flow of
economy.
Level of Employment Expected Minimum Sales
Proceeds
(N) (Expected Total
Expenditure) ADF ( in lakhs of workers) (Rs)

1 175

2 250

3 325

4 400

5 475

6 550
Y
Rs.
ADF = F (N)
MINIMUM RECEIPTS / INCOME

550
ADF = f ( N )
475 ADF = expected sales
receipts
400 by entrepreneurs
325 N= volume of employme
F= functional relationshi
250

175

O 1 2 3 4 5

EMPLOYMENT (N) IN LAKHS


EQUILIBRIUM LEVEL OF EMPLOYMENT THE
POINT OF EFFECTIVE DEMAND
EMPLOYEES ASF ADP COMPARISON DIRECTION
(N) EMPLOYMENT

1 100 175 ADF>ASF INCREASES

2 200 250 ADF>ASF INCREASES

3 300 325 ADF>ASF INCREASES

4 400 400 ADF=ASF EQUAL

5 500 475 ADF<ASF DECREASES


THE POINT OF EFFECTIVE DEMAND

Y
ASF
RECEIPTS / INCOME

Z
ADF
a E
R

O N1 N NF

VOLUME OF EMPLOYMENT (N)


 E is intersection of ASF & ADF = Point of effective demand.
 Beyond OR, entrepreneurs expect profits might be maximized
 Therefore as long as ADF > ASF i.e., as long as demand is more
than supply, entrepreneurs will want more employees until ADF
=ASF .
 N1 = more demand , less supply - require more employees
 N = demand = supply – enough employees ( 100% )
 NF = more supply , less demand – unemployment.
According to Keynes, Effective employment depends on 2 factors:
1. Consumption function
2. Investment function
CONSUMPTION FUNCTION
 This is the indicator level of effective demand
 Also called the “propensity of consume”, denotes consumption demand
or aggregate demand of the community, which depends on the size of
income.
 Consumption reacts to income variation
 As Income increases, consumption increases but not proportionally.
 In short – run, the amount of consumption is comparatively stable and
varies equally on change in income.
 Keynes, argued that, to sustain level of income and employment in the
economy, investment demand should increase.
INVESTMENT FUNCTION
 Real investment is addition of real capital assets and
accumulation of wealth.
 To invest is important but only second to employment.

 Effective demand for investment is more complex than the

consumption function itself.


 Volume of investment = volume of business community

 Therefore to invest entrepreneurs have to make more

profit thereby increasing demand.


 Which indeed creates more employment.

 Investment function depends on

(i) marginal efficiency of capital


(ii) rate of interests.
KEYNESIAN THEORY

EMPLOYMENT ASF

EFFECTIVE DEMAND ADF

CONSUMPTION INVESTEMENT G.EXPENDITURE


(C) (I) (G)

MEC RATE OF INTEREST


(Y) PROPENSITY
MONEY TO CONSUME SUPPLY DEMAND
PROSPECTIVE SUPPLY PRICE
INCOME YIELDS OF MONEY FOR MONEY
MOTIVES
TRANSACTIONAL
AVERAGE EXPECTATIONS
MARGINAL
PROPENSITY TO PROPENSITY
CONSUME TO CONSUMELONG RUN SHORT RUN PRECAUTION

SUBJECTIVE OBJECTIVE SPECULATIVE

KEYNESIAN THEORY IN A NUTSHELL


DRAWBACKS OF KEYNESIAN THEORY
 Capitalistic theory
 Outcome of Great Depression in 30’s
 Concentrates on short – run
 Static in nature.
 Closed economy
 Assumes perfect competition
 Purely macro – economics only.
 Not applicable in under developed
countries.
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