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Updated: Sep 27, 2023

Classical economists assumed full employment on the basis of Say's market law which states that " supply creates its own demand " . According to Keynes , under employment equilibrium is the normal feature . He explained his theory of employment on the basis of effective demand in his book ' General Theory of Employment , Interest and Money ' .

Relation of employment and output or national income

His theory is based on a short - run view . In the short run , it is assumed that capital equipment , population or manpower , technical knowledge , labour efficiency remain constant . Keynes theory says that the volume of employment depends on the level of national income and output . If capital , working force , technology and labour efficiency remain fixed , the national income can be increased only by employing more labour . According to Keynes , the increase in national income would mean increase in employment . The larger the volume of employment , the larger the national income . His theory of employment is based on the principle of effective demand .

Principle of effective demand . - Effective demand is that aggregate demand which is equal to aggregate supply . In other words , effective demand is the point where aggregate demand curve and aggregate supply curve intersect . Aggregate demand is the total of consumption expenditure and investment expenditure . As output , income and employment increases , aggregate demand also increases . For each level of output , employment and income there will be a corresponding level of aggregate demand . But , all aggregate demand is not effective demand . Aggregate demand which is equal to aggregate supply is effective demand . Effective demand being equal to total output as well as total expenditure , is also equal to national income . He explains his principle of effective demand using ' aggregate demand function or price ' and ' aggregate supply function or price ' . Effective demand is that ' aggregate demand price ' which becomes ' effective ' because it is equal to ' aggregate supply price ' and thus represent a position of ' short - run equilibrium ' .

Aggregate Demand Function or Price The aggregate demand function or price for the output of any given amount of employment is the total sum of money or proceeds which is expected from the sale of output produced when that quantity of labour is employed . The aggregate demand price represents the expected receipts when a given volume of employment is offered to workers . The aggregate demand curve or aggregate demand function represents a schedule of the proceeds expected from the sale of the output produced by different amounts of employment . Thus , a schedule of the proceeds expected from the sale of outputs resulting from varying amounts of employment is called ' the aggregate demand schedule or the aggregate demand function . The aggregate demand function shows the increase in the aggregate demand price as the amount of employment increases . Aggregate demand consist of total expenditure on consumption and investment ( C + I )

Aggregate Demand Schedule

​Employment level ( Number in lakhs )

​Expected proceeds from the sale of output ( in crores of rupees )













Aggregate Supply Function or Price

The aggregate supply price , when any given number of workers is employed , is the total cost of production of the output at a certain level of employment . It is the sum total of all payments made by entrepreneurs to all the factors of production producing that output . Dillad says , " This minimum price or proceeds , which will just induce employment on a given scale , is called the aggregate supply price of that amount of employment . "We can prepare an aggregate supply price schedule according to the total number of workers employed in the economy and we ' aggregate supply function . The greater the amount of proceeds , can have a corresponding ' aggregate supply price curve or the greater the amount of employment offered by the employers , taken together , to the workers in the economy . Since , more workers will be employed only if the employers in the aggregate expect to be paid more money for the larger output produced by these workers , the aggregate supply price curve will slope upwards to the right .

​Employment level ( Workers in number of lakhs )

​Aggregate supply schedule Annual money wages ( Rupees in thousands )

Assumptions Aggregate Supply Price ( Rupees of crores )






















Determination of equilibrium level of employment or determination of the point of effective demand

Keynes ' General Theory of Employment is based on the following assumptions :

( 1 ) Perfect Competition . There is a fairly high degree of competition in the markets .

( 2 ) Short period . - The time that is considered is the short - period .

( 3 ) Operation of diminishing returns . - There is the operation of diminishing returns to productive resources or increasing costs . part in economic

( 4 ) Absence of government activity . The government plays no significant part either as a taxer or as a spender .

( 5 ) A closed economy . - There is absence of the influence of exports and imports .

( 6 ) Static conditions . The General Theory does not trace out the effect of the future on the present economic events clearly .

( 7 ) Heroic aggregation . The relation in aggregates like the national income , saving and investment are better tools .

After having understood the concept of ' Aggregate Supply ( AS ) ' and ' Aggregate Demand ( AD ) ' , we are now in a position to explain the determination of the level of employment with the help of the Aggregate Supply ( AS ) and Aggregate Demand ( AD ) basing on the above assumptions .

The point of determination of the effective demand as a result of the interaction of the two functions ADF and ASF can be illustrated by means of the following diagram . expect In this diagram the curve AD represents ADF ( the aggregate p receipts which the entrepreneurs at varying levels of employment ) and the curve AS represents ASF ( the aggregate costs which the entrepreneurs must cover at varying levels of employment ) . The two curves intersect each other at E. This is the point of effective demand . At this point ADF and ASF are exactly balanced . ON is the employment available . OM is the receipts / costs . At any other point , the two curves cannot be in equilibrium .


So long as ADF is greater than ASF , the entrepreneurs shall go on employing more and more workers till ADF and ASF are exactly equal . The moment ASF ( cost ) exceeds ADF ( receipts ) further expansion of business activity and employment shall come to an end .

The aggregate demand price and the aggregate supply price , thus , determine the effective demand , which is the determinant of employment . Effective demand is met by the community in the form of output so that effective demand is equal to the total output . The total output , in its turn , results in the creation of income for the community . Or total output is equal to national income . Total output further comprises consumption goods and investment goods . Money spent on consumption goods andinvestment goods is equal to national expenditure . Hence his General Theory is called the theory of employment

Thus , Effective Demand = National Income = Value of National Output = National Expenditure = Expenditure on Consumption and Investment Goods .

Now , the ' General Theory of Keynes can be summarised as follows :

( 1 ) Total income depends on the volume of total employment .

( 2 ) Total employment depends on total effective demand and in equilibrium aggregate demand is equal to aggregate supply .

( 3 ) Aggregate supply depends on physical and technical conditions of production , and , in the short run , these do not often change ; hence , it is the changes in the aggregate demand that bring about changes in income and employment .

( 4 ) Effective demand is made up of ( a ) consumption demand and ( b ) investment demand .

( 5 ) Consumption demand depends on consumption function or propensity to consume , and , in the short - run , consumption function is relatively stable .

( 6 ) Investment demand depends on :

( a ) the marginal efficiency of capital , and

( b ) the rate of interest .

( 7 ) The marginal efficiency of capital depends on :

( a ) the expectation of profit yields and

( b ) replacement cost of capital assets .

( 8 ) The rate of interest depends on :

( a ) the quantity of money , and

( b ) the state of liquidity preference .




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