Wednesday, 25 May 2011

Keynes General Theory of Income and Employment or Explain the following concepts Effective Demand and Aggregate Demand

Keynes General Theory of Employment :-
Keynes offered this theory in 1936. Keynes explained in this theory that employment depends upon the income. If the standard of national income is higher then rate of employment will also be higher. On the other hand if the level of national income is lower then the level of employment will also be lower. The equilibrium level of income and employment will be that where aggregate demand is equal to the aggregate supply.

1. It has been assumed that period taken is short run.
2. There is no change in the amount of capital.
3. There is no change in technology and efficiency of labour.
4. There is no foreign trade.
5. There is no government interference.
6. The propensity to consume is stable.
7. There should be no change in the methods of production.
8. There should be no change in a distribution of wealth.
9. Employment is the function of the income.

Keynes proved this fact that supply can not create its own demand, and there is no tendency of the economy towards full employment. If at any time aggregate demand falls, then unemployment takes places and if aggregate demand increases then inflation takes place. As regards the question of national income and employment determination it is determined by the aggregate supply and aggregate demand.

According to Keynes aggregate supply is equal to national income at market price. In other words national income is equal to the price of goods and services produced in the country.The national income is divided into three parts, consumption saving and taxes. So Aggregate supply = National income = Consumption + Savings + Taxes
AS = Y = C + S + T

In the above Figure real national income is measured along OX axis and expected revenue along OY. This 45 degree curve "OS" shows the aggregate supply. It explains that which minimum revenue should be received to the producers and they may be able to produce a particular amount of goods and services and may be able to provide employment to the workers.

Aggregate demand is the amount of consumption and amount of investment expenditure at each level of income.
There are two components of aggregate demand.

1. Consumption expenditure ( C ).
2. Investment expenditure ( I ).
Aggregate demand can be expressed as Y = C + I

Consumption Expenditure :-
It depends upon the size of national income. If the size of national income is greater then greater amount will be spent on consumption. In other words the marginal propensity to consume is grater then the gap between consumption and income is small and the level of employment will be high.

Investment Expenditure :-
The investment expenditure depends upon the following two factors :

1. Marginal Efficiency of Capital
2. Current Rate of Interest
If the marginal efficiency of capital is lower than the rate of interest, the demand for investment will be low. The aggregate demand curve rises upward from left to right.

According to Keynes the level of income and employment is determined at a point there aggregate demand curve intersect aggregate supply curve.
Now by the following diagram we can explain it :

Explanation :- In the above diagram income is measured along OX-axis and consumption and investment along OY. OS curve shows the aggregate supply (45 degree) or C + S line. C + I is the aggregate demand curve.
Aggregate demand and supply curves intersect each other at the point "M". M is the point of effective demand and OP is the equilibrium level of national income. If we assume that national income is greater than OP in that situation new equilibrium point will be F. If total expenditure fall short then the aggregate supply, the producer will also reduce the production. Further income and employment will also reduce and again equilibrium will be M.


1. In the under developed countries there are so many other factors which are responsible for unemployment, like over population and lack of skill.
2. Perfect competition is not found in real world.
3. In the long run its chances of success are limited.
4. It is not applicable in socialistic economy.
5. This theory was produced by the depression of 1930 and it is not applicable in ordinary economic condition.

Anyhow this theory has much importance for all the countries.


Sagar. S 19 April 2014 at 03:39  

Thank you :)
Your work is greatly appreciated .

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