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Keynes' Effective Demand and Employment

The document discusses Keynes' theory of determining the equilibrium level of employment. It states that effective demand, which is desire plus ability and willingness to buy, is the starting point of Keynes' theory. The equilibrium level is determined by the intersection of the aggregate demand function and aggregate supply function. The aggregate demand function shows planned expenditures at different income levels, while the aggregate supply function shows the levels of income entrepreneurs will supply at different expenditure levels. Where the two functions intersect is the point of effective demand, which represents the equilibrium level of employment in the economy.

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76 views6 pages

Keynes' Effective Demand and Employment

The document discusses Keynes' theory of determining the equilibrium level of employment. It states that effective demand, which is desire plus ability and willingness to buy, is the starting point of Keynes' theory. The equilibrium level is determined by the intersection of the aggregate demand function and aggregate supply function. The aggregate demand function shows planned expenditures at different income levels, while the aggregate supply function shows the levels of income entrepreneurs will supply at different expenditure levels. Where the two functions intersect is the point of effective demand, which represents the equilibrium level of employment in the economy.

Uploaded by

startupbin33
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Determination of Equilibrium Level

of Employment:

The central problem of the General Theory is-

What determines the level of employment?

Keynes' answer is- effective demand. Effective


demand is the logical starting point of Keynes'
theory of employment. Effective demand means

desire plus ability and willingness to buy, i.e.,


actual expenditure. Effective demand depends
upon aggregate demand function and aggregate
supply function.

Aggregate demand function represents different

amounts of money which the entrepreneurs

expect to get from the sale of output at varying

levels of employment. Or, to put it differently,

aggregate demand function reveals planned or

intended expenditure at different levels of

income.
Aggregate demand schedule (AD curve in Figure

-7) slopes upward to the right, indicating that

as the expected sale proceeds increase, greater


number of workers will be employed. The AD

curve flattens at thhe later stages of employment

because marginal propensity to consume

declines as income increases.

Employment Output- Income

Effective Demand

Aggregate Supply Aggregate Demand


Funcbon Function

Consumption Investment

Size of Incomu Rate of Interest


Propensity Marginal Efficiency
to Consume of Capital

Prospective Supply Quantity Liquidity


Yield of Moeny
Price Prelerence

Transaction Speculative
Motive Precautionary Motive
Motve
Aggregate supply function represents different
amounts of money which the entrepreneurs

must get from the sale of output at varying

levels of employment. Or stated in a different

way, aggregate supply function represents

different levels of income (and thus output and

employment) which the entrepreneurs will


supply at different levels of expenditures.

Aggregate supply schedule (AS curve in Figure-

7) also slopes upwards to the right, indicating

that at higher levels of employment expected


minimum sale proceeds increase. After the full

employment level is reached (i.e., after point F),


AS curve becomes perfectly inelastic (a vertical

straight line) which shows that employment

cannot increase further even if minimum

expected sale proceeds increase.


AS

AE G
AD

N N N2
EMPLOYMENT
Fig. 7

The equilibrium level of employment is

determined at the point of intersection between

aggregate demand function and aggregate

supply function. This is also the point of


effective demand. Aggregate supply represents
costs, while aggregate demand represents

expected receipts of the entrepreneurs.


So long as receipts are greater than costs, the

employment will continue to increase. This

process will go on till receipts become equal to

costs. No employment will be offered to the

workers if costs are greater than receipts.

In Figure-7, point E is the point of effective

demand where AD curve and AS curve intersect

each other. ON is the equilibrium level of

employment. At this level, aggregate demand


(receipts) is equal to aggregate supply (costs). At
ON employment level, the entrepreneurs
maximise their profits and have no tendency
either to increase or decrease employment. At

no other level of employment, the economy will

be in equilibrium.
For example, at ON1 level of employment, thhe
expected receipts are greater than the expected
costs (AN1> BN^). This will induce
entrepreneurs to increase employment.

Similarly, at ONf employment level, expected


costs exceed expected receipts (FN> GN). Such

a level of employment will not be offered,

because it will involve losses.

Here two points are to be noted:

(i) The equilibrium level of employment as

represented by the point of effective demand

(point E) does not necessarily indicate a full-

employment equilibrium. As is clear from

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