Keynesian Theory of Employment

Keynesian Theory
of Employment
Dr. Abdul Azeez N.P.

Keynesian Theory of Employment
• Keynes has strongly criticised the classical theory in his book ‘General
Theory of Employment, Interest and Money’-1936.
• His theory of employment is widely accepted by modern economists.
• Keynes has invented new tools and techniques of economic analysis such as
consumption function, multiplier, marginal efficiency of capital, liquidity
preference, effective demand, etc.

Keynesian Theory of Employment
• In the short run, it is assumed by Keynes that capital equipment,

population, technology, and labour efficiency remain constant.
• That is why, according to Keynesian theory, volume of employment
depends on the level of national income and output.
• The larger the national income the larger the employment level and vice
versa.

The Principle of Effective Demand (or)
Keynes's Theory of Employment
• In a capitalist economy the level of employment depends on effective
demand.
• Keynes used the term 'effective demand' to denote the total demand for
goods and services at various levels of employment.
• Effective demand manifests in the aggregate expenditure of the

economy.
• The aggregate expenditure depends on level of national income.

Effective Demand
• According to Keynes, the level of employment in the short run depends

on aggregate effective demand for goods in the country.
• Greater the aggregate effective demand, the greater will be the volume
of employment and vice versa.
• According to him, the unemployment is the result of deficiency of

effective demand.
Principle of ‘Effective Demand’
 It is basic to Keynes’ analysis of income, output and employment.
 It tells us that in the short period, an economy’s aggregate income and

employment are determined by the level of aggregate demand which is
satisfied with aggregate supply.
Dr. Abdul Azeez N.P., AMU 6

Determinants of Effective Demand
According to Keynes, the level of employment in effective demand

depends on two factors:
(a) Aggregate Supply Function

&
(b) Aggregate Demand Function
Thus, equilibrium level of employment is determined by the

aggregate demand and aggregate supply functions.
Aggregate Demand Price
It is the total sum of money expected from the sale of the output produced when
that amount of labour is employed.
It refers to the expected revenue from the sale of output produced at a

particular level of employment.

Aggregate Demand Price
As level of employment increases aggregate demand curve rises

but at a diminishing rate, hence the slope of curve diminishes.
AD = f(N)
AD=Sale proceeds expected by entrepreneurs

N = Number of workers employed

Aggregate Supply Function
• Aggregate supply drawn as a function of employment.
• Aggregate supply refers to the total volume of all goods and services
available for consumption and investment.
• Money value of all goods and services produced in an economy is

known as national output/product.
• National product is also the payment made to the four factors of

production.
Aggregate Supply Price
It refers to the proceeds necessary from the sale of output at a

particular level of employment.
Thus each level of employment in the economy is related to a particular

aggregate supply price and there are different aggregate supply prices for
different levels of employment.

Aggregate Supply Function
The aggregate supply price is positively related to the level of

employment.
AS= f(N)
AS = Agg supply price of output

N = Number of workers employed

Determination of Effective Demand
The equilibrium level of employment is where aggregate demand price

equals the aggregate supply price
This may or may not be full employment.
It is not necessarily one of full employment but of underemployment

equilibrium.

Equilibrium Level of Employment
Effective Demand Z
AS
Income and expenditure
y* AD
n* N
L Employment

AS
E2 AD
Z
Income and expenditure
y* E1 AD
n* N
L LF
Employment
 Aggregate supply function is given (fixed in short run)
 Aggregate demand function play vital role
AD= C+ I
 Unemployment may be due to fall in C and I

Comparison between Classical and Keynes’
Theories
 Long run and short run
 Emphasis on supply and demand
 Different treatment to Investment and Saving functions
 Full employment and Underemployment equilibrium

Importance of Effective Demand
1. Invalidates Say’s Law of Market
2. Refutes Pigou’s Theory of wages
3. Importance of Investment
4. Govt. intervention
5. Paradox of poverty in the Midst of Potential Plenty
6. Determinants of Level of Employment
7. Under employment equilibrium
8. More importance to demand side

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Keynesian Theory

Dr. Abdul Azeez N.P.

• His theory of employment is widely accepted by modern economists.

Dr. Abdul Azeez N.P.

• In the short run, it is assumed by Keynes that capital equipment,

Dr. Abdul Azeez N.P.

• Effective demand manifests in the aggregate expenditure of the

• The aggregate expenditure depends on level of national income.

Dr. Abdul Azeez N.P.

• According to Keynes, the level of employment in the short run depends

• According to him, the unemployment is the result of deficiency of

 It is basic to Keynes’ analysis of income, output and employment.

 It tells us that in the short period, an economy’s aggregate income and

Dr. Abdul Azeez N.P., AMU 6

According to Keynes, the level of employment in effective demand

(a) Aggregate Supply Function

Thus, equilibrium level of employment is determined by the

It refers to the expected revenue from the sale of output produced at a

Dr. Abdul Azeez N.P.

As level of employment increases aggregate demand curve rises

AD=Sale proceeds expected by entrepreneurs

Dr. Abdul Azeez N.P.

• Aggregate supply drawn as a function of employment.

• Money value of all goods and services produced in an economy is

• National product is also the payment made to the four factors of

It refers to the proceeds necessary from the sale of output at a

Thus each level of employment in the economy is related to a particular

Dr. Abdul Azeez N.P.

The aggregate supply price is positively related to the level of

AS = Agg supply price of output

Dr. Abdul Azeez N.P.

The equilibrium level of employment is where aggregate demand price

This may or may not be full employment.

It is not necessarily one of full employment but of underemployment

Dr. Abdul Azeez N.P.

Dr. Abdul Azeez N.P.

 Aggregate supply function is given (fixed in short run)

 Aggregate demand function play vital role

 Unemployment may be due to fall in C and I

Dr. Abdul Azeez N.P.

 Long run and short run

 Emphasis on supply and demand

 Different treatment to Investment and Saving functions

 Full employment and Underemployment equilibrium

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