KEYNES THEORY OF INCOME AND EMPLOYMENT
O
INTRODUCTION
Kyns thory of emplo,'nent ls calld the ffectivs dmand theory of emploJmnt. ording to this theory, unemployment arises due ro rhc dsficiency ro effeclive dcna and method of removing uncmployment is to raise cllcctivc dernand. Similarly, it wis onty rcs who corcludcd that the maincause ofuncmploymcnt was de ficiency ol aggrcgar c demand. E-. thcrcforc, s ggcstcd that if aggregate demand is incrcascd, unemploymcnr can bc .emoved. grcgale denand is of two lypes : Tbc dcnand for consumpdon soods and demund tbr rslment goods. ln .\hort pcriod, aggrcgate demand can bc raiscd by incrcascd ;nvcstmotrt. :1rcs also favourod the state intervenlion for rcmoving unomploynenr in lhc cconomy.
Assumptions of the Theory
Perlsct Comp;lilion (ir) Diminishing inal Prodoctivity of Factors (y) Monoy Illusion (ri) Moncy acrs as a Slore of value ) Limilod rolc of coverDment (viit) Saving Invesrmert Funcrion (rr) Under cmplormcnt rilibriun (r) Labour acts as a variablc factor.
Closd Economy
Kcynesian thcory of income is bassed on thc following assunplions
(t) Short Period (ii)
(rl)
VARL{BLES OF THE THEORY
Keynes uscd many variables in his theory which can bt hroadly dividcd inro rhrec groups. civcn Elements. First there are variahles which halc hcen assumud as given hlcausc : change so slowly lhat their effects in short run can bc ignored. Thcy arc (l]) ths quality : quanlity of labour a'd capital s !ock (, ) t echniques of p(rduct ion (c) dcgrce ofcompetirion .onsumcr ldsrc\ (c) the structurc of thc socicty. Indepen dent Variabls (or Causs). GeneraUy indepcndent variables arc thc causes.
l.
2.
variablcs show thc bchaviour patterns of the sociely. In other words, thoy represent basic lunctions or rclationships. There are four independcnr variables(i) Tho consumplion function ; (ti) The invcstment tutrction or thc marginal ctficicncy of investmenr schodule ;
The liquidity prcfercnce function ; The quantity of money fixed by thc monctary aulhoriry. All these variablcs arc stated in wage units. 3. Dependnt Variabls (Thse ar the enects). Thc dcpsndent variablcs of Kcynesiar .ql arc (a) The level of unemploymcnt, Output and inconc, a.d (b) rho ratc of inieresr. rr.s makes rate of interest as an itrdepcndcnt variable. Bu!, according ro llansco, rate of ::rsl is diterminate, and nol a delerminanl. Ralc of inreresr alons whh narional incomc hcr are mutually dctcrmincd for independent variablcs.
(iii) (ir)
EXPI-ANATION OF KEYI\ESIAN THEORY According to Keynesian theory of cmploymcnt, in the short run the rotal production
national income of a capitalislic cconomy dcpend on the lcvcl of emplolmnt. Thc lvcl .n ployment depends on effctive demand. Effective dem and is that levcl of aggregate demand
KUY\L5 lIlEorrl', Ol' rL
l\(iollli,\\D L\'lll,ol!il]\.
'd
rh..r\
$hiih
d.m!.d ind lggrcgalL suppL!. Ihc lcvel ol Jn.l \i., r--..
equal [Link] supply. So, ellcctiic dcmand is lh' csscncc ol Kcyrcsra: [Link] lo rhis Lheory, Lhc lcvcl r:l cmplo!mcnt i5 detcrmincd hv th,: [Link],
rL
i.
cmplor-monr incteascs as
lbs lolol ol cllcclil'
.\ccording to Kcynosian theoly of c plo)_mcnt -loral Oui rt - Nalronll lncome and Nalional incomo dcpcnds on thc levcl ol onrployftcnl
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Enrploymoni dcpends on clic0tivc dcmand
i1
Ellcctivc demand dcpcnds on aggregatc dcmand and aggrcgatc supply.
EFFECT VE OEMANO
AGGBEGATE Sl.]PPLY (G VENI
---1
AGGBEGATE OEMAND DEPENDS ON
CONSUMPl' ON EXPENDITURE (STABLE N THE SPOFT PEFLOD) T OEPNDS ON
S ZE
]NVES'IMENT
OF
{-] PPOP:NS TY \COtrtE TO CONS!ME
:FF C]ENCY OF
CAPI AL DEPENDS ON
]NTEFEST
DEPENOS ON
+
PAOSPECT VE
SUPE:Y
OEMAND MONEY (G
L QL.-I CITY
PF CE FOF MONEY OF
VlN
N TFI E
PFEF:FENCE
DEPENDS
SHOFT PEF OD)
SPECULAT VE
r,toi vE
MOT V
MO-i'VE
O
t;9. I
lablc Representation
The delerntinalion oI
pioymcnt is cxplaincd with the hclp
ol loll{rwing rablc
and
Table I Dtermination of the Lctol of Emplolmnt
}]m
10
SuDDh
Allllresate Dsmand
120
rlnd in Lnr
200 200 300
2S0
20 30
360
bYM
KIIY^_ES
l HlioRY OF INCOME AND EMPLOYMENT
4{)
bn
400 500 600 '700
4{)
5m
600 680
50
[ccl
Equilibrium Fall Fall 760 800 80 Fall 840 900 90 Fall 920 1000 100 F ." rh" utou" "tur".t tablc 1. we see that when the level of employment is zero even thor aggregate demand is Rs. 120 cr and aggregate supply [Link] The r(ason tor this is that [Link] ao snend some amuunl on consu;plion As cmPloymcnt incredser up lo 50 Lakh ine.e ir inc'eo.e in aggregatc demand is alongwilh incrcase in aggrcgate supplyalthough aggrcgalc demanrl is rnore than aggtegate suPPly. As such the producers will continu to Produc more. As a rcsult of it, rnorJlabourers wilt be mPloyed when 60 Lakh [Link] employment aqsresatc demand bccomes equal to aggregata supply, tiz , Rs 600 crore. lt witl be th position in the economy. lt ii at this point equilibrium level of cmployment vill he
60 't0
dctermincd. Thus after enploying 60 lakh persons as more and more persons arc employed, aggregate demand lalls short of aggregate supply. Hence, it will not bc wo(h while for thc cntreprsrcur6 ro givc work to morc than 50 lath persons.
i.
'[Link];[Link]
i
i.
DiagramReprese[tation ln tigurc I, X axis masures employment
(qudl to aggregate suPPl) As we see lhal
rncome whilc Y-aris expecled rcceiPl has been lakeD E is the equilibrirm point. There aggregate demand
I
[Link] demand function does nol slart from lhe -^ o;isin: It implie' th"r when thcre is no emplo,'nent H600 spcnd un consumpootr rl l,i cvcn rhe pcople havc cven the DcuDle have to sPend on consumption lf !l rhc lcvcl il cmploymcnt dicreases. then the dcmaod f
Ie
bo)
rEsun' Pruuuwtso ls greater llran suppty. ^s is grearer lhan s pply. As a resuh, producers o n'niu.. rnu'. pruduirion and rhe cmpl('yment H ,'nnorruniries will inrrease up to poinl E on lhe i .,ii"; ;;;. tr;. r"*i;[Link].i"t rn",.^c", rr'.n $ rhc supply is greatcr than demand. As a result,
EMPLOYMENT INCOME nnrduccrs produre less producls and employment decrease up to point E Thereforc. E "noununitics equilibrium point of employncnl. Therefore. Fig. 1. '. ihe ,recording to Kcynes, the volume ol emPloymeol is qivcn by the point o[ intersection betweon aggregate demand and aggregate iupply.
700
Consumption funclion isthe core of Keynesian thcoryof employment. Keyns"Propnslty to Consume' or 'Consumption Fuction' rneans whcn income increases, consumption also incrcascs but not 10 thc same cxtent as the increase in income. Thus it rolates to the general rclalionship between income and consumption levels in (he economy. According to Keynes, [Link] iemand depends upon two determinants, namely, tho level of-coffiumption and level oi-inv;stnent. To Keynes, consqrnption was a function of current real income i4.
CONSUMPTION TUNCTION
where
( -
c ="r(v)
Slaods lor aggtegale crnsumplion
