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KEYNESIAN ECONOMICS : General Theory of Emp: Interest & Money

1. Full employment is not normal feature 2. Unemployment equilibrium is normal. 3. Short Run Theory : Amount of Capital, Population, labour Force, Technology, do not change.

In the short run, higher level of income and employment can be attained by injection of macro economic measures which will lead to increase in aggregate demand for goods and services.

In a developed economy, employment depends on level of effective demand.

Agg. Supply Price : Total amount of money which all entrepreneurs taken together must expect to receive from the sale of output produced by given number of Labourers.

Aggregate Supply Price :

The minimum expected sale proceeds required to induce firms to produce and output and to provide employment on a given scale is called the aggregate supply price of that output. aggregate supply price increases with increase in the level of employment and vise versa. At full employment , no increase in cost or sales proceeds can generate employment further.

Aggregate Demand Price :

Total money receipts expected by all the firms in the economy taken together from the sale of their products produced by a given number of workers. When the firms expect to earn through increased expenditure of the community on goods and services, they will employ more workers and vise versa.

Equilibrium Determination

The equilibrium between ADP and ASP is established at the point where two curves intersect each other. Here proceeds expected is just equal to the level which induce firms to offer that employment.

Keynesian Theory of Employment Concept of Effective Demand.

Aggregate Demand Function (AD=total exp=C+I) aggregate supply function. As=F(N) AS is the aggregate supply price N=number of workers employed.

Income saved does not necessarily Create Demand=AD<AS Investment demand < Desired savings causes unemployment Factors determining Savings and investment are different.

Savings depends on income, old age, social security network, education, marriage of children, housing need etc.



upon (a) Expected rate of profit. (b) Rate of interest. (c) Technological progress (d) Population growth

_Wage reduction of general nature may not bring full employment _Wages determine both the cost of production and also level of income of people. _One mans exp is another mans income. Reduction in wages leads to fall in aggregate demand.

Even when wage rates are perfectly flexible, unemployment will prevail in the economy if aggregate demand is deficient. Classical economics is relevant for individual industry and firm analysis, valid for partial equilibrium and not general equilibrium. Capitalist economy can not automatically attain a state of full employment. Govt. has to play a pro-active role through monetary policy, fiscal policy, and other economic policies.

Classicals stood for Laissez faire policy; Keynes for active govt. intervention and Important role for money supply in carrying out corrections in aggregate demand.

Comparison Between Classicals and Keynesians Classicals Keynasians Economy is always in Full employment full employment. equilibrium is an exception. Wage and interest General reduction in flexibilities restores wages throughout the full employment economy can lead to equilibrium, if fall in demand. disturbed.

Monetary expansion create inflation.

may Inflation will arise only after full employment has been achieved.

Interest rate brings about Savings & investment is equality between Savings influenced by level of income and investment and expected return on investment.

Investment is interest elastic. Interest sensitivity investment may not adequate.

of be

Classicals depend on monetary policy for raising the level of income employment etc.

Keynesians depend on Fiscal Policy (public expenditure, deficit financing) for reaching full employment equilibrium. Classicals place Keynes treats supply great emphasis on (Y) as given and supply side for attaches great establishing significance to equilibrium. demand.

S & I decisions are made by same group of people and interest rate brings about equality between the investment and savings.

Works in long run.

S & I decisions are taken by different groups of people changes in the economy are the result of changes in income and expenditure and not the rate of interest. Works in short run All are dead in the long run

Under Employment Vs Full Employment

Keynes was of the view that under/unemployment is a normal situation of free market economy and full employment is an exception. The insufficiency of investment to fill the gap between income and consumption is responsible for the situation of under employment equilibrium.

Three ways to bridge the gap between income and consumption are: (a)Fiscal relief's to consumers and investors. (b)Easy availability of credit at lower interest rates. (c)Government investments in

Conclusion _The great depression of 1930s destroyed the belief in says law. _1.5 crore workers were unemployed. _General glut in the economy particularly U.S economy. _Says law does not provide explanation for rise and fall of employment.

Functions of Flexible Wage

According to Keynes: Wage cut in an industry may not have harmful effects, but a general wage cut can trigger fall in demand and pave the way for recession and depression. wage has two aspects: (a) Cost (b) Income

Empirically researches have found that investment in capital goods does tend to rise when the stock market rises and to fall when the market falls, although the relationship is not always strong. Limitation : In practice, stock prices reflect many assets besides capital, such as the patents a firm holds or the reputation of a firms products. Thus changes in stock prices are imperfect measure of the changes in the market value of capital.

Policy Implications of Keynesian Economics

1. Manage effective demand through active intervention 2. Monetary policy intervention (a) Higher rate of growth in money supply (b) Manipulating interest rate to encourage private investment 3. Fiscal policy

Reduce taxation - direct taxes and indirect taxes to give a boost to demand Increase in government expenditure to push up the demand. Choose projects having greater intensity of labour per unit of output. Focus on supply of wage goods.

Aggregate supply refers to the total quantity of goods and services that the nations business willingly produce and sell in a given period

aggregate supply would depend on available of (a)Capital, Labour and Technology (b)Price level and costs (c)Potential output In general, business would like to sell more if prices keep on rising and give them higher profits

Aggregate Demand: Aggregate demand refers to total amount of money that different sector of the economy willingly spend in a given period It is the sum of spending by consumers, business and governments and it depends on the level of prices as well as on Monetary, Fiscal policy and other factors

Macro Economic Equilibrium

Macro economic equilibrium is a combination of overall price and quantity at which all buyers are satisfied with their purchases, sales and prices. It occurs at the interaction of aggregate demand and supply curves. It represents overall price level where firms willingly produce