Thus, in Keynesian theory of income determination, investment does not vary with change in income. Hence, the price variable gets less attention while entire focus is on the determination of equilibrium level of income, which is determined solely by the aggregate demand. But Y 3 is in excess of the full-employment level of income and is therefore not attainable. Thus aggregate demand is synonymous with aggregate expenditure in the economy. If such a rise in the price level takes place, the entire labor supply schedule shifts downward, and involuntary unemployment is eliminated. So aggregate demand should be raised in order to raise level of employment. Aggregate Demand Price : Aggregate demand price is different from demand for products of individual organizations and industries.
Introduction to Keynesian Theory: Keynes was the first to develop a systematic theory of employment in his book. This gap between current investment and required investment level shows a inflationary gap. This multiplier refers to the money-creation process that results from a system of fractional reserve banking. In the Indian economy today there are a large number of involuntarily unemployed workers crying out for employment. Aggregate demand price and aggregate supply price together contribute to determine effective demand, which further helps in estimating the level of employment of an economy at a particular period of time. The marginal efficiency of capital means the expected rate of profit which the business community hopes to get from the investment in capital Fig.
We proceed with the theory of income determination by considering the consumption component first. Thus income or total output measures the aggregate supply of goods and services. Harrod-Domar in their famous dynamic growth models emphasized that investment not only creates demand but also new productive capacity. Because these unemployed workers and resources earn no income, they cannot purchase goods and services. In the short run, stock of capital remains constant and therefore output can be increased by increasing the amount of labour employed.
The equilibrium level of income or output depends on the relationship between the aggregate demand curve and aggregate supply curve. If it is an open economy as is usually the case, then a part of increment in income will also be spent on the imports of consumer goods. This curve of consumption function slopes upward from left to right, which shows that as income increases the amount of consumption demand also increases. The purpose of the present essay is to provide a broad, simple outline of the theory. Features of Keynesian Theory of Employment: The following are the main features of the Keynesian theory of employment which determine its basic nature: i It is general theory in the sense that- a it deals with all levels of employment, whether it is full employment, widespread unemployment or some intermediate level; b it explains inflation as readily as it does unemployment, because basically both situations are a matter of volume of employment, and c it relates to changes in the employment and output in the economic system as a whole. These two methods of income determination are classified as income-expenditure approach and saving- investment approach. In response to this, Keynes advocated a countercyclical fiscal policy in which, during the boom periods, the government ought to increase taxes or cut spending, and during periods of economic woe, the government should undertake.
One problem is that the actual value of the multiplier effect is likely to change at different points of the economic cycle. This sets in motion the operation of the multiplier in the reverse and as will be seen from the 10. Therefore, change in consumption can occur only if there is change in income. Conclusion: In short, the Keynesian theory is not general; it is not applicable in all places and at all times. Glenview: Scott, Foresman and Co. First, the people who save are not necessary those who make investment; while it is the general public which save but only few people constituting the entrepreneurial class undertakes investment. However, when the amount of sales receipt increases, the organization starts employing more and more workers.
But the reverse process will not stop here. C 0 curve is the investment function at consumption level Rs. The portion of production that is purchased by households is called consumption, C. Aggregate Demand The total expenditure of an economy can be divided in to four categories of spending. The Keynesian multiplier effect is very small in developing countries like India since there is not much excess capacity in consumer goods industries.
Introduction The action of government relating to its expenditures, transfers and taxes is called the fiscal policy. And he attributed unemployment to deficiency in aggregate demand. An increase in government purchases, for example, can be thought of as an upward shift in the investment demand schedule of Figure 1. In Keynes view, the level of employment of any country depends on its effective demand. Investment being autonomous of income means that it does not change with the level of income. Tobin, James 1947 Liquidity Preference and.
Y from the horizontal axis to vertical axis. However, the amount of labour employed out of this given size of population can vary depending upon the demand for labour. Prices also do not react quickly, and only gradually change when monetary policy interventions are made. But Keynes proved that it was not sound that is why the problem of involuntary unemployment was common in the free-market capitalist economies. This is because monetary demand or expenditure generated by investment in any one industry would be easily met by the increase in production capacity in a variety of industries.
Instead, he proposed that the government spend more money, which would increase consumer demand in the economy. There are four independent variables: i The consumption function; ii The investment function or the marginal efficiency of investment schedule; iii The liquidity preference function; iv The quantity of money fixed by the monetary authority. People hold money M in cash for three motives: transactions, precautionary and speculative. The wider the range to industries over which initial investment is undertaken, the greater will be the multiplier effect. The system is then, determinate i. Paying off debts: The first leakage in the multiplier process occurs in the form of payment of debts by the people, especially by businessmen.
However, through changes in monetary policy and fiscal policy by the Government the consumption function can be shifted. Delays in sourcing raw materials, components and finding sufficient skilled labour can limit the initial impact of the spending projects. He recommended state intervention to raise effective demand in order to increase the level of employment in the economy. However, if due to some bottlenecks output of goods cannot be increased in response to increasing demand, prices will rise and as a result the real multiplier effect will be small. It will be seen from Fig.