Keynes General Theory of Income and Employment

Keynes General Theory of Income and Employment

(a) Total Employment depends on Total output, which is equal to total income. So National Income = Total Employment.

(b) Total Value of employment depends on Effective Demand.

(c) Effective Demand is composed of Aggregate Demand Function (ADF) and Aggregate Supply Function (ASF). The Effective demand at the equilibrium price where ADF = ASF.

(d) ASF is given in the Short period, and ADF is the significant factor on Keynes's theory.

(e) ADF depends on total expenditure, which is composed of Consumption and Investment Function.

(f) Consumption Function depends on :- (i) Size of Income, (ii) Propensity to Consume. Keynes assumed consumption function to be stable in the short run.

(g) Investment Function depends on :- (i) Marginal Efficiency of Capital (MEC), (ii) Rate of Interest (Ri). Keynes considered Investment Function as a highly unstable factor.

(h) MEC is determined by :- (i) Prospective Yield, (ii) Supply price of Capital Assets. Keynes considered MEC as a highly fluctuating phenomenon because it depends on business psychology.

(i) Rate of Interest (Ri) is determined by Supply of Money and Demand for Money (Liquidity Preference). Supply of money is regulated by monetary authorities. Liquidity preference is determined by Transaction, Precautionary, Speculative motives, etc. Keynes considered rate of interest as a stable phenomenon.

(j) According to Keynes, Investment Expenditure is the main determinant of the level of employment. The greater the difference between MEC and Ri the higher the inducement to invest and vive-versa. Since Rate of Interest (Ri) is stable in the short run, MEC, which is unstable, is the main determinant of Investment Function.

(k) The theory concludes that to raise employment, effective demand should be raised. So, Investment Expenditure must be raised by filling the gap between an increase in investment and consumption. Lack of Effective Demand leads to unemployment.