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The Keynesian theory of employment was developed by J.M. Keynes in 1936 in his famous book The General Theory of Employment, Interest and Money. Before Keynes, classical economists believed that unemployment was temporary and that the economy naturally moved towards full employment. Keynes rejected this view and argued that unemployment is caused by deficiency of aggregate demand. According to him, an economy can remain in underemployment equilibrium for a long period.
The foundation of Keynesian employment theory is the principle of effective demand. Effective demand is the level of aggregate demand at which aggregate demand equals aggregate supply. It represents demand backed by purchasing power.
Employment depends upon effective demand for consumption and investment goods. When effective demand decreases, output and employment also decrease.
Aggregate demand function shows the relationship between employment and expected income from the sale of output. The expected proceeds are known as Aggregate Demand Price (ADP). As employment increases, output and expected income also increase.
Aggregate supply function represents the minimum income that entrepreneurs must receive to employ a certain number of workers. It shows the supply price corresponding to different levels of employment.
Equilibrium level of employment is determined at the point where Aggregate Demand Function equals Aggregate Supply Function (ADF = ASF). According to Keynes, this equilibrium may occur at less than full employment.
Consumption function refers to the functional relationship between income and consumption. It shows how consumption expenditure changes with change in income. There is a positive relationship between income and consumption.
It is the ratio of total consumption to total income.
It measures the change in consumption due to change in income.
According to Keynes, when income increases, consumption also increases but not by the same proportion because part of the income is saved.
Saving is the portion of income not spent on consumption.
Excessive saving reduces consumption and aggregate demand, which leads to decline in income, output, employment, and ultimately saving itself. Thus, thrift may result in poverty instead of wealth.
Investment refers to the addition to capital stock during a period.
MEC is the expected rate of return over cost from a capital asset. Investment decision depends upon comparison between MEC and market rate of interest.
In a two-sector economy (Household + Firm):
Multiplier shows the multiple effect of an initial change in investment on national income.
Higher MPC leads to larger multiplier.
Includes Household, Business, and Government sectors. It is a closed economy without foreign trade.
Includes Household, Business, Government, and Foreign sectors. It is an open economy with exports and imports.
It shows the effect of change in exports and imports on national income.