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3
Chapter
Theories of
Employment and Income

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CHAPTER SNAPSHOT
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3.1 Introduction
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3.6 Effective Demand


3.2 Meaning of full Employment 3.6.1 Aggregate Demand Function
3.3 Unemployment and its types 3.6.2 Aggregate Supply Function
3.4 Classical Theory of Employment 3.6.3 Equilibrium between ADF and ASF
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3.4.1 Say’s Law of Market 3.7 Comparison of Classicism and Keynesianism


3.5 Keynes’ Theory of Employment and Income
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[41]

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Theories of Employment and Income Sura’s - XII Std - Economics

Model Questions
Part - A 7. The core of the classical theory of employment
is _______.
Multiple Choice Questions  1 Mark (a) Law of Diminishing Return

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(b) Law of Demand
1. Every able bodied person who is willing to
(c) Law of Markets
work at the prevailing wage rate is employed
called as _______. (d) Law of Consumption

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(a) Full employment  [Ans. (c) Law of Markets]
(b) Under employment 8. Keynes attributes unemployment to _______.
(c) Unemployment (a) A lack of effective supply
(d) Employment opportunity (b) A lock of effective demand

s.
 [Ans. (a) Full employment] (c) A lack of both
2. Structural unemployment is a feature in a (d) None of the above
_______.  [Ans. (b) A lock of effective demand]

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(a) Static society (b) Socialist society 9. _______ Flexibility brings equality between
(c) Dynamic society (d) Mixed economy saving and investment.
 [Ans. (c) Dynamic society] (a) Demand (b) Supply
3. In disguised unemployment, the marginal (c) Capital (d) Interest
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productivity of labour is _______.  [Ans. (d) Interest]
(a) Zero (b) One 10. _______ theory is a turning point in the
ab

(c) Two (d) Positive development of modern economic theory.


 [Ans. (a) Zero] (a) Keynes’ (b) Say’s
(c) Classical (d) Employment
4. The main concention of the Classical Economic
Theory is _______.  [Ans. (a) Keynes’]
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(a) Under employment 11. The basic concept used in Keynes Theory of
(b) Economy is always in the state of equilibrium Employment and Income is _______.
(c) Demand creates its supply (a) Aggregate demand
(d) Imperfect competition (b) Aggregate supply
.s

[Ans. (b) Economy is always in the state of (c) Effective demand


equilibrium] (d) Marginal Propensity Consume
5. J.B. Say is a _______.  [Ans. (c) Effective demand]
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(a) Neo Classical Economist 12. The component of aggregate demand is


(b) Classical Economist _______.
(c) Modern Economist (a) Personal demand
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(d) New Economist (b) Government expenditure


 [Ans. (b) Classical Economist] (c) Only export
(d) Only import
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6. According to Keynes, which type of


unemployment prevails in capitalist economy?  [Ans. (b) Government expenditure]
(a) Full employment 13. Aggregate supply is equal to _______.
(b) Voluntary unemployment (a) C + I + G
(c) Involuntary unemployment (b) C + S + G + (x-m)
(d) Under employment (c) C + S + T + (x-m)
 [Ans. (d) Under employment] (d) C + S + T + Rf [Ans. (d) C + S + T + Rf]
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Sura’s - XII Std - Economics www.nammakalvi.org Chapter 3


14. Keynes theory pursues to replace laissez faire Part - B
by _______.
(a) No government intervention Answer the following questions in
(b) Maximum intervention one or two sentences 2 Marks
(c) State intervention in certain situation
21. Define full employment.
(d) Private sector intervention

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Ans. Full employment means that persons who are
[Ans. (c) State intervention in certain
situation] willing to work and able to work must have
employment or a job.
15. In Keynes theory of employment and income,

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_______ is the basic cause of economic 22. What is the main feature of rural
depression. unemployment?
(a) Less production Ans. The major feature of rural unemployment is
(b) More demand the existence of unemployment in the form
(c) Inelastic supply of disguised unemployment and seasonal

s.
(d) Less aggregate demand in relation to unemployment.
productive capacity.
23. Give short note on frictional unemployment.
[Ans. (d) Less aggregate demand in relation to

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productive capacity.] Ans. (i) Frictional unemployment arises due to
imbalance between supply of labour and
16. Classical theory advocates _______. demand for labour.
(a) Balanced budget (ii) The persons who lose jobs and in search
(b) Unbalanced budget of jobs are also included under frictional
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(c) Surplus budget unemployment.
(d) Deficit budget [Ans. (a) Balanced budget]
24. Give reasons for labour retrenchment at
ab

17. Keynes theory emphasized on _______ present situation.


equilibrium.
Ans. (i) Employers must classify what the reason
(a) Very short run (b) Short run
is for the possible retrenchment during
(c) Very long run (d) Long run the consultation process.
 [Ans. (b) Short run]
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(ii) Israelstam explains that employers have


18. According to classical theory, rate of interest is to consult with labour unions as the
a reward for _______. representatives of employers in cases
(a) Investment (b) Demand where there is unionisation.
.s

(c) Capital (d) Saving


25. List out the assumptions of Say’s law.
 [Ans. (d) Saving]
Ans. (i) No single buyer or seller of commodity or
19. In Keynes theory , the demand for and supply an input can effect price.
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of money are determined by _______.


(ii) There will be a perfect competition in
(a) Rate of interest
labour and product market.
(b) Effective demand
(iii) Money acts only as a medium of exchange.
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(c) Aggregate demand


(d) Aggregate supply (iv) Long-run analysis.
 [Ans. (a) Rate of interest] 26. What is effective demand?
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20. Say’s law stressed the operation of _______ in Ans. (i) Effective demand denotes money actually
the economy. spend by the people on products of
(a) Induced price mechanism Industry.
(b) Automatic price mechanism (ii) The money which entrepreneurs receive
(c) Induced demand is paid in the form of rent, wages, interest
(d) Induced investment and profit.
 [Ans. (b) Automatic price mechanism]
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Theories of Employment and Income Sura’s - XII Std - Economics


27. What are the components of aggregate supply? (ii) According to Pigou, under free
Ans. The components of aggregate supply are competition the tendency of the economic
(i) Aggregate (desired) consumption system is automatically provide full
expenditure (C). employment in the labour market.
(ii) Aggregate (desired) savings (S). (iii) Unemployment results from rigidy in the
wage structure and state interference in

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(iii) Net tax payments (T).
the market economy.
(iv) Personal desired transfer payments to the
(iv) According to Prof. Pigou if all government
foreigners (RF).
interferences are removed and forces of

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Part - C competition are allowed to work freely,
Answer the following questions in the market induced changes of wage rates
will lead to full employment.
one paragraph 3 Marks
(v) Prof. Pigou illustrated the following
28. Explain the following in short

s.
equation.
(i) Seasonal unemployment
N = q. Y/W
(ii) Frictional unemployment
N =  No. of workers, Q = Fraction

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(iii) Educated unemployment
Ans. (i) Seasonal unemployment :
of income earned as wages and
salaries.
(1) This type of unemployment occurs
during certain seasons of the year. Y = Full employment level of national
income.
(2) In agriculture and agro based
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industries like sugar production W = Wage rate
activities are carried out only in (vi) If Y is given, N can be increased only by
ab

some seasons. reduction in W.


(ii) Frictional unemployment (Temporary (vii) This can be explained with following
unemployment) : figure.
(1) Frictional unemployment arises Reduced wage rate increases employment
due to imbalance between supply of y
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labour and demand for labour. d


(2) The persons who lose jobs and in W/P1 S (A)
search of jobs are also included W/P E
Real Wage
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under frictional unemployment


(iii) Educated unemployment : P
(1) Sometimes educated people are
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under employment or unemployed


when qualification does not match
the job. 0 W/O NF N
(2) Faulty education system, Lack
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of Employable skills, mass


student turnout etc., jobs are (B)
highly responsible for educated W/P1
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unemployment in India.
W/P
29. According to classical theory of employment, MPL
how wage reduction solve the problem of
unemployment diagramatically explain. N
Ans. (i) During the days of the great depression 0
Employment
Prof. A.C. Pigou supplied the most logical
part of unemployment.
47
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Sura’s - XII Std - Economics www.nammakalvi.org Chapter 3

(viii) S - is the supply curve of labour. 30. Write short note on the implications of Say’s
(ix) D - is the demand curve of labour. law.
(x) The intersection of two curves shows full Ans. (i) There is no possibility for over production
employment at E. or unemployment.
(xi) If the wage is reduced to the level of W/P (ii) If there exist unutilized resources in the

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then unemployment disappears and attain economy it is profitable to employ them
full employment. upto the point of full employment.
(xii) This is shown in panel (B). (iii) As automatic price mechanism operates
in the economy, there is no need for

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(xiii) MP1 is the Marginal product of labour
curve which slopes downward as more government intervention.
labour is employed. (iv) Interest flexibility brings about equality
(xiv) The full employment level is reached between saving and investment.
when the wage rate falls from W/P1 to (v) Money performs only the medium of

s.
W/P level. exchange function in the economy, as
(xv) There is a cut in the money wage, the people will not hold idle money.
real wage is also reduced to the same

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extent which reduces unemployment and
ultimately brings full employment.
31. Explain Keynes’ theory in the form of flow chart.
Ans.
o
Effective Demand = Output = Income = Employment
ab

Aggregate Supply Aggregate Demand


Function Function
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Consumption Investment
Function Function
.s

Size of Income Propensity to Marginal Rate of Interest


consumer (MPC) Efficiency of
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Capital (MEC)
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Supply price of Prospective yield


Capital from Capital
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Liquidity preference Supply of Money


of the public in the Economy

Transaction Precautionary Speculative


Motive Motive Motive

48
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Sura’s - XII Std - Economics www.nammakalvi.org Chapter 3

Part - D (2) Labour saving devices are


responsible for technological
Answer the following questions in unemployment.
one page 5 Marks (vi) Structural Unemployment :
35. Describe the types of unemployment. (1) Structural unemployment is due to
drastic change in the structure of

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Ans. Types of Unemployment are,
the society.
(i) Cyclical Unemployment
(2) For example rise in demand for
(ii) Sesonal Unemployment
mobile phone has adversely affected

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(iii) Frictional Unemployment the demand for cameras, tape
(iv) Educated Unemployment recorders etc.
(v) Technical Unemployment (vii) Disguised unemployment :
(vi) Structural Unemployment Disguised unemployment occurs when more
(vii) Disguised Unemployment people are working than what is actually

s.
(i) Cyclical Unemployment : required.
(1) This unemployment exists during 36. Critically explain Say’s law of market.
the downturn phase of Trade cycle

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Ans. According to Say, “When goods are produced
in the economy.
by firms in the economy, they pay reward to
(2) It is caused by deficiency of effective the factors of production. The households after
demand. receiving rewards of the factors of production
(ii) Seasonal Unemployment : spend the amount on the purchase of goods
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(1) This type of unemployment occurs and services produced by them. Therefore,
during certain seasons of the year. each product produced in the economy creates
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(2) In agriculture and agro based demand equal to its value in the market.
industries like sugar, production Criticisms of say’s law :
activities are carried out only in
The following are the criticisms against say’s law.
some seasons.
(i) According to Keynes, supply does not
(iii) Frictional Unemployment :
create its demand. It is not applicable
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(1) Frictional unemployment arises where demand does not increase as much
due to imbalance between supply of as production increases.
labour and demand for labour.
(ii) Automatic adjustment process will not
(2) The persons who lose jobs and in
.s

remove unemployment.
search of jobs are also included
under frictional unemployment. (iii) Money is not neutral. Individuals hold
money for unforeseen contingencies
(iv) Educated Unemployment :
while businessmen keep cash reserve for
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(1) Sometimes educated people are


future activities.
under employed or unemployed
when qualification does not match (iv) Say’s law is based on the proposition that
supply creates its own demand and there
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the job.
is no over production.
(2) Faulty education system, Lack of
employable skills, mass student (v) Keynes regards full employment as
turnout etc., are highly responsible a special case because there is under
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for educated unemployment in employment in capitalist economies.


India. (vi) The need for state intervention arises in
(v) Technical Unemployment : the case of general over production and
(1) Modern technology being capital mass unemployment.
intensive requires less labourers
and contributes to technological
unemployment.
50
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Theories of Employment and Income Sura’s - XII Std - Economics


37. Narrate the equilibrium between ADF and There are two approaches to determination of
ASF with diagram. the equilibrium level of income in Keynesian
Ans. (i) Under the Keynes theory of employment, theory these are :
a simple two sector economy consisting 1. Aggregate demand - Aggregate supply
of the households sector and the business approach
sector is taken to understand the

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2. Saving - Investment approach
equilibrium between ADF and ASF. Diagram explanation :
(ii) All the decisions concerning consumption (i) In the figure, the aggregate demand and
expenditure are taken by the individual aggregate supply reach equilibrium at

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households, while the business firms take point - E.
decisions concerning investment.
(ii) The employment level is N0 at that point.
(iii) It is also assumed that consumption
(iii) At ON1 employment, the aggregate supply
function is linear and planned investment
is N1 R1

s.
is autonomous.
(iv) They are able to produce M1 N1
y AS (v) The expected level of profit is M1 R1
E AD (vi) To attain this level of profit, entrepreneurs

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will employ more labourers.
(vii) The tendency to employ more labour will
Proceed and Cast

M1 stop once they reach point E.


(viii) At all levels of employment beyond ON0,
o
the aggregate demand curve is below the
aggregate supply curve indicating loss to
R1 the producers.
ab

(ix) Thus the concept of effective demand


becomes significant in explaining the
0 N1 N0 Nf x under employment equilibrium.
Employment
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38. Explain the differences between Classical theory and Keynes theory.
Ans.
S. No. Keynesianism Classicism
.s

1. Short-run equilibrium Long-run equilibrium


2. Saving is a vice Saving is a social virtue
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3. The function of money is a medium of The function of money is to act as a medium of


exchange on the one side and a store of exchange.
value on the other side.
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4. Macro approach to national problems Micro foundation to Macro problems


5. State intervention is advocated Champions of Laissez fair policy.
6. Applicable to all situations. Full Applicable only to the full employment situation.
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employment and less than full


employment.
7. Capitalism has inherent contradictions Capitalism is well and good
8. Budgeting should be adjusted to the Balanced budget.
requirements of economy.

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Sura’s - XII Std - Economics www.nammakalvi.org Chapter 3

9. The equality between saving and The equality between saving and investment is
investment is advanced through achieved through changes of rate of interest.
changes in income.
10. Rate of interest is determined by the Rate of interest is determined by saving and
demand for and supply of money. investment.

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11. Rate of interest is a flow Rate of interest is a stock.
12. Demand creates its own supply. Supply creates its own demand.
13. Rate of interest is a reward for parting Rate of interest is a reward for savings.

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with liquidity.

Additional Questions and Answers

s.
Part - A 5. Rate of interest is a stock
(a) Socialism (b) Keynesianism
Multiple Choice Questions  1 Mark (c) Classicism (d) All the above

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(i) Choose the Correct Option.  [Ans. (c) Classicism]

1. Every able bodied person who is willing to 6. ‘Demand creates its own supply’ - who said
work at the prevailing wage rate but not this.
employed is called _______ (a) Socialism (b) Keynesianism
o
(a) Full employment (c) Classicism (d) Both ‘b’ and ‘c’
(b) Under employment  [Ans. (b) Keynesianism]
ab

(c) Unemployment 7. ‘Rate of interest is a reward for parting with


(d) Employment opportunity liquidity’ - Its belongs to which theory.
 [Ans. (c) Unemployment] (a) Keynesianism (b) Socialism
(c) Both ‘a’ and ‘b’ (d) Classicism
2. Interest flexibility brings equality between
 [Ans. (a) Keynesianism]
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_______.
(a) Income and consumption 8. Every economy in the world aims at attaining
(b) Saving and investment the level of _______.
(c) Demand and supply (a) Full employment
.s

(d) Labour and capital (b) Unemployment


 [Ans. (b) Saving and investment] (c) Seasonal unemployment
(d) Educated unemployment
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3. ‘Full employment as the absence of involuntary


unemployment’ was said by _______.  [Ans. (a) Full employment]
(a) J.B. Say (b) Ricardo 9. A person receives his income from _______.
(c) J.M. Keynes (d) Adamsmith
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(a) production
 [Ans. (c) J.M. Keynes] (b) purchase
4. Full employment as “that level of employment (c) sales
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at which any further increase in spending (d) None of the above


would resort in an inflationary spiral of wages  [Ans. (a) production]
and prices” who quote this above concept. 10. Total production equals to _______.
(a) J.M. Keynes (b) Lerner (a) total income (b) gross income
(c) J.B. Say (d) All the above (c) net income (d) total sales
 [Ans. (b) Lerner]  [Ans. (a) total income]

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Sura’s - XII Std - Economics www.nammakalvi.org Chapter 3

5. (a) Consumption - Co-extensive 2. Keynesianism :


(b) Annual - Annual demand (a) State investment is advocated
produce (b) Short run equilibrium
(c) Saving - Investment (c) Saving is a vice
(d) Labour - Medium of (d) Balanced budget

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exchange  [Ans. (d) Balanced budget]

 [Ans. (d) Labour - Medium of exchange] 3. Classicism :


(a) Capitalism is well and good.

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(vi) Assertion, Reason. (b) Macro approach to national problems.
1. Assertion (A) : Disguised unemployment (c) Champions of Laissez - faire policy.
occurs when more people are working than (d) Long run equilibrium
what is actually required. [Ans. (b) 
Macro approach to national

s.
Reason (R) : In Disguised unemployment problems.]
Marginal Productivity of labour is zero or less
or negative. Part - B
Answer

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(a) Both A and R are true and R is the Correct the following questions in
explanation of A one or two sentences  2 Marks
(b) Both A and R are true but R is not the correct
1. Give short note on Cyclical unemployment?
explanation of A
Ans. Cyclical Unemployment :
o
(c) A is the true but R is false
(i) This unemployment exists during the
(d) A is false but R is true downturn phase of trade cycle in the
ab

[Ans. (a) B oth A and R are true and R is the economy.


Correct explanation of A]
(ii) In a business cycle during the period
2. Assertion (A) : “The General Theory of of recession and depression, income
employment, interest and money” published and output fall leading to widespread
in 1936. unemployment.
ur

Reason (R) : A highly significant work that 2. What are the four components of aggregate
marked a turning point in the development of demand?
modern economic theory.
Ans. (i) Consumption Demand
.s

(a) Both A and R are true and R is the Correct


(ii) Investment Demand
explanation of A
(iii) Government Expenditure
(b) Both A and R are true but R is not the correct
(iv) Net Export (Export - Import)
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explanation of A
(c) A is the true but R is false 3. Write the formula for aggregate supply?
(d) A is false but R is true Ans. Aggregate supply = C + S + T + RF = Aggregate
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 income generated in the economy.


[Ans. (b) B oth A and R are true but R is not
the correct explanation of A] 4. Write any two types of unemployment?
(iv) Pick the Odd one Out. Ans. (i) Seasonal unemployment
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(ii) Frictional unemployment


1. “Supply creates its own demand”. - who
5. What is Say’s law of market?
enunciated this proposition.
Ans. J.B. Say enunciated the proposition that “Supply
(a) J.S. Mill (b) J.M. Keynes
creates its own demand”. Hence there cannot
(c) David Ricardo (d) J.B. Say
be general over production or the problem of
 [Ans. (d) J.B. Say] unemployment in the economy.

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Theories of Employment and Income Sura’s - XII Std - Economics


6. Write a short note about Keynes theory? 2. Write a short note on effective demand? 
Ans. Keynes theory of employment was based on Ans. (i) Effective demand denotes money actually
the view of the short run. According to him, spent by the people on products of
the factors of production such as capital goods, industry.
supply of labour, technology and efficiency of (ii) The money which entrepreneurs receive
labour remain unchanged while determining

m
is paid in the form of rent, wages, interest
the level of employment. and profit.
7. What is unemployment? (iii) Therefore effective demand equals
national income.

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Ans. Unemployment is problem faced when there are
people, who are willing to work and able to work (iv) An increase in the aggregate effective
but can’t find suitable job. demand would increase the level of
employment. A decline in total effective
8. What are the assumptions of Say’s Law of
demand would lead to unemployment.
Market?

s.
Therefore,
Ans. (i) Ceteris paribus (constant extraneous
(v) Thus the total employment of a country
variables).
can be determined with the help of total
(ii) Existence of Normal Conditions.

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demand of a country.
(iii) Existence of a Laissez-faire Capitalist
Economy. 3. Give the factors on which the aggregate
demand depends.
9. What are the two factors depend on MEC? Ans. The aggregate demand is the amount of money
Ans. MEC depends on two factors namely which entrepreneurs expect to get by selling the
o
(i) Prospective yield of capital asset output produced by the number of labourers
(ii) Supply price of capital employed. Therefore, it is the expected income
ab

or revenue from the sale of output at different


10. What are the three motives of liquidity levels of employment.
preference? Aggregate demand has the following four
Ans. Liquidity preference is based on three motives. components :
They are,
ur

(i) Consumption demand


(i) Transaction motive (ii) Investment demand
(ii) Precautionary motive (iii) Government expenditure and
(iii) Speculative motive (iv) Net Export (export – import)
.s

Part - C 4. Write the criticism of Say’s Law.


Answer the following questions in Ans. The following are the criticisms against Say’s
 3 Marks law :
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one paragraph
1. Explain the classical theory about (i) According to Keynes, supply does not
unemployment? create its demand. It is not applicable
where demand does not increase as much
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Ans. (i) The classical theory of employment is


composed of different views of classical as production increases.
economists on the issue of income and (ii) Automatic adjustment process will not
employment in the economy. remove unemployment. Unemployment
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(ii) Classical economists assumed that the can be removed by increase in the rate of
economy operates as the live of full investment.
employment without inflation in the long (iii) Money is not neutral. Individuals hold
period. money for unforeseen contingencies
(iii) They also assumed that wages and prices while businessmen keep cash reserve for
of goods were flexible and the competitive future activities.
market existed in the economy.

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Sura’s - XII Std - Economics www.nammakalvi.org Chapter 3

5. What are the components of aggregate supply? (x) Unutilized resources used until reaches
Ans. The components of aggregate supply are, full employment.
(i) Aggregate (desired) consumption (xi) No Government intervention automatic
expenditure (C). Price adjustment mechanism operated.
(ii) Aggregate (desired) private savings (S). 2. Draw the diagram ADF.

m
(iii) Net tax payments (T) (Total tax payment
to be received by the government Ans. y
minus transfer payments, subsidy and
AD
interest payments to be incurred by the

Aggregate Demand

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government) and
(iv) Personal (desired) transfer payments
to the foreigners (Rf)(eg. Donations to
international relief efforts)

s.
Part - D
Answer the following questions in x

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0 Employment
one page  5 Marks
1. List out all assumption of say’s law of market? 3. Draw the diagram for Aggregate supply curve
Ans. Assumption of the Say’s law of market : diagram.
o
(i) No single buyer (or) seller of commodity Ans. y
or an input can affect price. Z1
ab

(ii) Full employment.


Expected Proceeds

(iii) People are motivated by self interest


and self-interest determines economic
decisions. z
ur

(iv) The laissez fair policy is essential for an


automatic and self adjusting process of
full employment.
(v) There will be a perfect competition.
.s

(vi) There is wage - price flexibility.


(vii) Money acts only as a medium of exchange. 0 Nf x
Employment
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(viii) Long run analysis.


(ix) There is no possibility for over production
or unemployment.
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