Keynesian Theory of Employment - Macroeconomics | Macro Economics - B Com PDF Download

An Outline of the Keynesian Theory of Employment with Flow Chart!

The gist of the Keynesian theory of employment may be laid down in the following propositions:

1. The national income is equal to the volume of total employment since total output equals total income, but depends upon the total employment.

2. Total volume of employment depends upon and originates from the level of effective demand in an economy.

3. Effective demand is composed of two elements (i) the aggregate demand function, and (ii) the aggregate supply function. Effective demand is determined at the equilibrium point of the aggregate demand function and the aggregate supply function.

4. Keynes, however, assumed aggregate supply function to be given in the short period and regarded aggregate demand function as the most significant element in his theory.

5. The aggregate demand function is composed of the consumption function and the investment function. In other words, the aggregate demand determining the rate of spending or the flow of expenditure in an economy consists of the consumption expenditure and the investment expenditure.

6. The consumption function or the consumption expenditure is determined by (i) the size of income and (ii) propensity of the people to consume. Keynes, however, regarded the consumption function to be a stable phenomenon in the short run.

7. The investment function or the inducement to invest, determining the volume of investment in an economy, depends on (i) the marginal efficiency of capital and (ii) the rate of interest. Keynes pointed out that unlike the consumption function the investment function is a highly unstable factor of the aggregate demand.

8. The marginal efficiency of capital is determined by (i) the prospective yields of capital assets, and (ii) the supply prices or the replacement costs of these assets.

Keynes considered marginal efficiency of capital to be a highly fluctuating phenomenon because expectations regarding prospective yields from capital assets are highly influenced by business psychology, business optimism or pessimism.

9. The rate of interest depends on (i) the liquidity preference function, and (ii) the quantity of money. The liquidity preference of the community is determined by three motives, (a) transactions motive, (b) precautionary motive, (c) speculative motive, whiles the supply of money or the quantity of money, is regulated by the monetary authority.

Keynes however, considered the rate of interact as a relatively stable phenomenon.

10. Keynes viewed that investment expenditure or rather the inducement to invest, the main determinant of the level of employment in an economy, depends on the difference between the marginal efficiency of capital and the rate of interest. The greater the difference, the more will be the inducement to invest and vice versa. Since the rate of interest is assumed to be relatively stable in the short run, it is the marginal efficiency of capital that assumes the place of pride. And the instability characteristics of the marginal efficiency of capital are the fundamental cause of the instability of the investment function.

11. The General Theory concludes that in order to increase the level of employment and income in an economy, it is essential to lift the effective demand and, for this, investment expenditure should be increased. Thus, investment and employment go together. And investment expenditure must be high enough to fill the gap which arises between income and consumption as the income increases. Any deficiency in the investment demand leads to unemployment to that extent. Thus, the crucial factor in Keynes’ employment income theory is investment.

12. Keynes’ theory of employment, in essence, contains the logic of an economics of less than full employment or “Depression economics.”