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.
Dr. Abdul Azeez N.P.
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.
Dr. Abdul Azeez N.P.
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.
Dr. Abdul Azeez N.P.
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.
Dr. Abdul Azeez N.P.
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.
Dr. Abdul Azeez N.P.
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.
Dr. Abdul Azeez N.P.
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
Dr. Abdul Azeez N.P.
Dr. Abdul Azeez N.P.
Dr. Abdul Azeez N.P.
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.
Dr. Abdul Azeez N.P.
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.
Dr. Abdul Azeez N.P.
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
Dr. Abdul Azeez N.P.
Dr. Abdul Azeez N.P.
Dr. Abdul Azeez N.P.
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.
Dr. Abdul Azeez N.P.
Dr. Abdul Azeez N.P.
Equilibrium Level of Employment
Effective Demand Z
AS
Income and expenditure
y* AD
n* N
L Employment
Dr. Abdul Azeez N.P.
Dr. Abdul Azeez N.P.
AS
Equilibrium Level of Employment
E2 AD
Z
Income and expenditure
y* E1 AD
n* N
L LF
Employment
Dr. Abdul Azeez N.P.
Dr. Abdul Azeez N.P., AMU 22
Equilibrium Level of 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
Dr. Abdul Azeez N.P.
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
Dr. Abdul Azeez N.P.
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
Dr. Abdul Azeez N.P., AMU 25
