KEYNESIAN THEORY OF
EMPLOYMENT
DR. REETA CHOUHAN
Department of Economics
St. Aloysius’ College (Autonomous), Jabalpur (M.P.)
Reaccredited ‘A+’ Grade by NAAC : (CGPA:3.68/4.00)
College with Potential for Excellence by UGC
DST – FIST Supported & DBT - STAR College
Introduction
 The theory of Keynes was against the belief that the market forces
in capitalist economy adjust themselves to attain equilibrium.
 Keynes criticized classical economists and advocated his own
employment theory.
The Great Depression had proved that market forces cannot attain
equilibrium themselves.
 The Keynes theory of employment was based on the view of the
short run.
 He assumed that the factors of production remain unchanged while
determining the level of employment.
 Therefore, according to Keynes, level of employment is dependent
on national income and output.
 He advocated that if there is an increase in national income, there
would be an increase in level of employment and vice versa.
Assumptions of the Theory
 Short-period analysis.
 Perfect competition in the market.
 Closed economy.
 Macro-economic analysis that deals with aggregates.
 Operation of the law of diminishing returns or increasing costs.
 Neutrality of government.
 He assumes that labour has money illusion.
Principle of Effective Demand
 The level of employment in the short run is dependent on the aggregate effective
demand.
An increase in the aggregate effective demand would increase the level of
employment and vice-versa.
 A decline in total effective demand would lead to unemployment.
 Effective demand signifies the money spent on the consumption of goods and
services and on investment.
 Therefore, effective demand is equal to total expenditure as well as national
income and national output.
Effective demand = National Income = National Output
 Therefore effective demand affects employment level of a country, national
income, and national output.
 It declines due to the mismatch of income and consumption and this decline lead
to unemployment.
 Therefore, the gap between the income and consumption rate should be reduced
by increasing the number of investment opportunities.
 Consequently, effective demand also increases, which further helps in bringing
full employment condition.
Determination of Effective Demand
 Aggregate Demand Price
 Aggregate Supply Price
Aggregate Demand Price
The aggregate supply price is an amount of money
which a producer expect from the sale of output at
different levels of employment.
The aggregate demand price represents the expected
receipts when a given volume of employment is offered to
workers.
The essence of aggregate demand function is that the
greater the number of workers employed, the larger the
output. Thus the aggregate demand price increases as the
amount of employment increases, and vice versa.
Aggregate Supply Price
The aggregate supply price is an amount of money which a
producer must receive from the sale of output at varying level of
employment.
According to Dillard, the minimum price which will induce
employment on a given scale, is called the ‘aggregate supply
price’ of that amount of employment.
If the output does not fetch sufficient price so as to cover the
cost, the entrepreneurs will employ less number of workers.
Therefore, different numbers of workers will be employed at
different supply prices.
Difference Between the Aggregate Supply Price and
Aggregate Demand Price
 In aggregate supply price, organizations should receive money from
the sale of output produced by, while in aggregate demand price the
amount of money may or may not be received employing a specific
number of workers.
However, in aggregate demand price, organizations expect to
receive from the sale of output produced by a specific number of
workers. Therefore, in aggregate supply price, the amount of money
is the necessary amount that should be received by the organization.
Determination of Equilibrium Level of Employment
The equilibrium level of
employment is ON2, as at this
point the AD curve intersects the
AS curve or the AD is just equal
to AS. The amount of proceeds,
i.e., OM which entrepreneurs
expect to receive from providing
ON2 number of jobs is just equal
to the amount i.e. OM which
they must receive if the
employment of that number of
workers is to be worthwhile for
the entrepreneurs.
Beyond the N2, the AD curve lies below AS curve, which
means that the amount expected by the entrepreneurs is
less that the amount they considered necessary to
receive. Therefore, the number of persons employed will be
reduced in the economy.
The slope of AS curve, at first rises slowly and then after a
point it rises sharply. It means that at beginning as more and
more men are employed, the cost of output rises slowly. But
as the amount received by the entrepreneurs increases they
employ more and more men. As soon as the entrepreneurs start
getting OT amount, they will be prepared to employ all of the
workers.
It is not necessary that the equilibrium level of
employment is always at full employment level. It can
be in equilibrium at less that full employment or an underemployment equilibrium.
Actually there is always some unemployment in the
economy, even in economically advanced countries.
According to Keynes, full employment is the level of
employment beyond which further increases in effective
demand do not increase output and employment.
At the point of intersection of
AS and AD, the entrepreneurs
are
maximising
their
profits. The profit will be
reduced
if
volume
of
employment is more or less
that this point. Even if the
point does not represent full
employment.
In this situation, the economy
has not yet reached the full
employment level, and there are
still NN’ number of workers
unemployed in the economy.
 If the favorable circumstances push the
economy and the AD increases so much
that the entrepreneurs now find it
worthwhile to employ ON’ men at the
equilibrium point E’, where the economy
is in full employment level.
The root cause of the underemployment
equilibrium
is
the
deficiency of AD. This deficiency is due
to the gap between income and
consumption. As income increases
consumption
increases
but
not
proportionately.
If the investment is increased
sufficiently to cover this gap, there can
be full employment. Hence the gap
between income and consumption and
insufficiency of investment to this gap are
responsible
for
under-employment
equilibrium.
Two Important Points
i)
The equilibrium level of employment does not necessarily
indicate a full-employment equilibrium. There exists NN1
amount of unemployment at E point of effective demand.
Keynes’ main contribution is the demonstration that less- thanfull employment equilibrium is possible and, in a capitalist
economy, this is normal situation.
i)
Aggregate supply function cannot be manipulated and thus is not
of much practical significance. In order to attain full-employment
level of ON1 aggregate demand must be raised from AD curve to
AD1 curve.
Criticisms of Keynesian Theory
 It does not provide a comprehensive treatment of unemployment.
 There exists no direct and determinable relationship between effective
demand and volume of employment.
 It assumes perfect competition which is not a very realistic assumption.
 It deals with short-run phenomenon, no attention in the long-run
problems.
 Keynesian economics is static in nature.
 This theory is purely macro-economic theory which deals with
aggregates.
 This analysis does not take into account the impact of international
trade.
 It pays little attention to deal with the inflationary situation.
 This theory fails to deal socialist economic system.
 Keynesian theory is not applicable in underdeveloped countries.
 Keynes suggested expansion of aggregate demand and discouragement
to savings.
Conclusion
In short, the Keynesian theory is not
general; it is not applicable in all places
and at all times. As Harris has remarked“Those who seek universal truths,
applicable in all places at all times had
better not waste their time on the General
Theory.”
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