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Thus the level of income depends on the level of employment. As the income of a person increases, his tendency to consume comparatively reduces. (Compare points F and G). When people start demanding another product in place of a product temporarily, unemployment would increase due to a fall in total demand, it shall be of an irregular nature. Such unemployment is known as cyclical unemployment. Keynes used his income‐expenditure model to argue that the economy's equilibrium level of output or real GDP may not corresPond to the natural level of real GDP. The labour market also attains equilibrium when aggregate demand price is equal to aggregate supply price. Meaning of Effective Demand 2. Adam Smith wrote a classic book entitled, 'An Enquiry into the Nature and Causes of the Wealth of Nations' in 1776.Since the publication of that book, a body of classic economic theory was developed gradually. As a result investment falls even if the rate of interest remains constant at r0. It also depends on the propensity (or tendency) to consume. Due to this depression, unemployment spread in all independent capitalist economies. But this type of unemployment cannot last for too long due to flexibility of wages and prices. In an advanced capitalist country, the level of employment depends on aggregate effective demand. The reason is that more workers are now willing to work at the new real wage (W0/P0). In the money market, the demand for capital shall be more even during the period of high rates of interest, if in view of the investors, capital is more efficient. So more workers will be demanded by the profit-seeking competitive firms. As a result the level of employment will increase. And this is exactly what had happened in the wake of the US depression of 1929. In the face of rising wage bill, firms will employ more and more workers if and only if the extra wage costs are covered by the extra sales revenue so that the total wage bill is the aggregate supply price. Thus the basic point to note here is that aggregate employment depends on aggregate effective demand. Keynes basically explained and analysed the determinants of employment in an advanced capitalist economy and, in the process, identified the causes of unemployment. The efficiency (productivity) of labour also does not increase much. The Monetarist View of the Great Depression: The monetarists, led by Milton Friedman, pointed out that the Great Depression occurred due to the fact that the USA’s central bank or the Federal Reserve Board (or Fed., in short) drastically reduced the money supply during the period 1929-33. 1691) Tuesdays 11:30-13:00/Fridays 13:00-14:30 E-Mail: firstname.lastname@example.org TBT 315 Course Syllabus _____ A. Thus, in short, in simple Keynesian model, the level of employment depends on aggregate output and aggregate output, in its turn, depends on aggregate effective demand. According to Keynes, the equilibrium levels of national income and employment are determined by the interaction of aggregate demand curve (AD) and aggregate supply curve (AS). So he explained only output and income changes, holding prices constant in the short run. 5.3 where the AD and AS curves intersect. Keynes pointed out that during depression the Say’s law does not work. Theories of Employment: Classical Theory of Employment:. In this case the real cost of labour will remain the same and the problem of involuntary unemployment will be solved. Thus whatever may be the magnitude (or rate) of increase in the money supply, it will be absorbed by the people in the form of liquid (cash) balance. So, if more workers are employed, the variable cost of production will increase proportionately. So full employment situation is likely to return. Post was not sent - check your email addresses! Kurihara, etc, have criticized the Keynesian theory vary strongly. According to Keynes the Great Depression occurred due to a sudden fall in the marginal efficiency of capital which led to a fall in investment even at a constant rate of interest. The equilibrium of national income occurs where AD is equal to AS. Keynes analyzed that situation of unemployment and tried to find the reason and solution to that problem. These points become clear when we refer to the underemployment equilibrium. This is why Keynes said that the end of full employment is the beginning of inflation. And this makes investment volatile. 5.3 together determine the level of employment in the economy. Therefore the consumption levels will also be different. General Theory of Employment, Interest, and Money, Macro Economics - Importance, Limitations and Difficulties - Exam Notes, Creative Commons Attribution-ShareAlike 4.0 International License. The converse is also true. The curve showing aggregate demand price, viz., ADP also slopes, upward from left to right. Moreover, high wages reduce the rate of labour turnover. It intersects the aggregate supply curve at point F. This causes aggregate output (real GNP) to fall from Y0 to Y1. Such unemployment occurs if some workers do not want to work even if plenty of jobs are available and workers have substantial choice of jobs. If the desire to save from their particular income is more than the desire for substitution expenditure has become a reverse relationship, demand, and employment increase i.e., when the desire to save, among people is lesser than the substitution expenditure in the society, demand, and employment increases. Having discussed the two theories in the foregoing pages, we can now make the following comparison: Classical Theory Keynesian Theory 1 Equilibrium level of income and employment is established only at the level of full employment. The marginal efficiency of capital depends on the substitution cost and the anticipated profits. If aggregate demand increases and the aggregate demand curve shifts upward, then more output can be produced by employing more workers to meet the extra demand for goods. They take an increase in money wage as equivalent to an increase in real wage even if there is a proportionate or more than proportionate rise in the price level. For all these reasons Keynes postulated that the level of employment depends on the volume of production. 12. This refers to infinite elasticity of demand for money. But they can prevent their money wage from falling even when there is excess supply of labour. A fall in employment occurs due to fall in output and output falls due to fall in aggregate effective demand. When aggregate demand falls, there is widespread pessimism and MEC falls. When aggregate demand price is lower than aggregate supply price, firms will reduce the number of workers hired. So even if the demand for labour increases, the wage rate will not rise. 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