Keynesian Theory of ncome an mp oyment
Keynesian Theory of Income and Employment
John Maynard Keynes
General Theory of Employment, Interest and Money (1936)
attacked the major postulates of classical of classical theory.
Classical Theory of Income and Employment
Existence of full employment without inflation Closed laissez faire capitalist economy without foreign trade Homogeneous labour Y=C+I , = Wages and prices are flexible Money wages and real wages are directly related and proportional Capital stock and technological knowledge are given Say’s law of Markets
Say’s law of Markets
J.B Say ‘Supply creates its own demand ’ There is no general over production since, SS = DD , S=I qu r um: a us men roug ra e o n eres r [S and I = f (r )] ↑ ‘r ’ ⇒ ↑ saving ↓ ‘r ’ ⇒ ↑ demand for investments
Say’s law of Markets
If over production, Labours leave.
Short run
Quantity Theory of Money
MV = PT M = Supply of Money V = Velocity of Money P = Price level = o ume o
ransac ons
Money Supply (MV) = Total Value of Output (PT)
M causes proportional change in P
Ms is Neutral
Summary of Classical Model
Level of Employment ⇒ Labour market Demand for and Supply of Labour, f (w/p)
Total Output ⇒ Goods Market Employment (N), Capital Stock (K) and ec n ca now e ge
Price Level ⇒ Money Market ⇒ MV = PT
Great depression
Criticisms Against Classical Theory
Keynes rejected the assumption of full employment Rejected Say’s Law Laissez faire is not self adjusting Capitalist system not self adjusting In Classical, Money transaction and precautionary only not Speculative Neutrality of Money Keynes integrated monetary and real sectrors of the economy.
Keynesian Theory of Employment, Interest and Money
J. M Keynes
General theory of employment, Interest and Money (1936)
Short run theory (amount of capital, labour force, technology, etc does not change)
Keynesian Theory of Employment
Effective Demand Level of employment in short run is determined by effective demand Aggregate Demand (Price) = Aggregate Supply (Price)
Aggregate Demand
the amount of goods and services people wish to purchase at the existing price level Expected receipts when a given volume of employment is offered to workers. ⇑ Number of workers ⇑ Output ar es a eren eve s o emp oymen coz, employment income consumption Components: Consumption (C) + Investment (I) + Govt. Expenditure (G) & Net Exports (X-M)
Aggregate Supply
the amount of final goods and services produced in an economy at the existing price level
Minimum sales proceeds…..total cost of production at a given level of employment
Z = φ (N)
⇑ Employment ⇑ Aggregate supply price of the output
Slopes upward from left to right; when economy reaches full employment the AS curve becomes vertical.
Effective Demand AS
l e v e l e c i r
Point of Effective Demand
S2
D2 AD
o
Out put, Income
Importance of Effective Demand
Rejection of Say’s Law - All income is not invested. Refutes Pigou’s Wage Cut theory – Pigou: cut in money wage increase employment But, ↓ Money wage ↓ Consumption ↓ Employment Importance of Investment – investment increases employment and Determines Employment Emphasis on Demand side Explaining Paradox of poverty – Poverty in the midst of plenty – Unemployment in Capitalism Psychological Law – ↑ income ↑consumption but less than proportionally Gap between income and consumption not filled by investment
Keynes Theory of Employment and Income
Consumption
Saving
Investment
Govt. Expenditure
e expor s
Consumption Function
C = f (Y) , where, Y = Real Current National Income Average Propensity to Consume (APC) Proportion of whole income which is spend on consumption. APC =
Total Consumptio n
Average Propensity to Save (APS) = 1 – APC Marginal Propensity to Consume (MPC) Ratio of change in consumption due to a change in income
MPC =
Total Income
=
C
Change in Consumption Change in Income
Marginal Propensity to Save = 1 – MPC
=
∆C ∆Y
Psychological Law of Consumption
Men are disposed as a rule and on the average to increase in their consumption as their income increases but not by as much as the increase in their income.
Hence MPC is always less than 1.
Investment Function
Real investment - Increment in Capital goods Financial Investment – purchase of stocks of existing companies, doesn’t increase productive capacity of the economy. I depends on MEC, should be higher than rate of interest (r ). ‘’ MEC is the expected rate of return (discounted) over cost of a new capital good. Induced investment – profit or income motivated Autonomous Investment – independent of level of income, influenced by exogenous factors
Keynesian Theory
Total Output = National Income
National Income ⇒ Level of Employment , Y = f (N)
Employment ⇒ Effective Demand =
Effective Demand Aggregate Supply (g)
Aggregate Demand Consumption
Size of ‘Y’
APC/MPC Prospective Yield
Transactionary Motive
Investment MEC
r Supply DD SS Price Money Money(g)
Precautionary Motive
Speculative Motive
Determination of National Income
Aggregate Demand = Aggregate Supply
Aggregate Demand = C + I
Aggregate Supply: total monetary value of goods and services produced in an economy
Y = f N,K^,T^
Planned output 450 line
Determination of National Income AS C+I+G
Z C+I E
o
Y
Y =NI
National Income: Change in Investment C+I+G
Z C+I+I’ Full Employment F C+I C
E
∆ I
∆Y
O
Y
YF
NI
Multiplier (K)
Change in Income (Y), as a result of Change in Investment (I) at a given propensity to Consume. Y = K. I
K =
1
−
or
If MPC = 0.75, Multiplier = = 4
1
Inflationary Gap
The amount by which the actual aggregate demand exceeds the level of national income corresponding to full employment is known as inflationary gap because this excess a re ate demand causes inflation or rise in prices. C + I + G > the full employment GNP level
Inflationary Gap C+I+G
Inflationary Gap Z C+I+G’ H T
C+I+G E Full Employment Output
O
YF
YX
NI
Deflationary Gap
Deflationary Gap represents the difference between the actual aggregate demand and the aggregate demand which is required to establish the equilibrium at full employment level of Income.
Depression)
(Causes
Deflationary Gap C+I+G
Deflationary Gap Z C+I+G E C+I+G’
Q Full Employment Output
O
YX
YF
NI
Thank you……………………..
