Keynesian theory of employment is based on the following assumptions:
(1) The Short Period:
Keynes was writing about the short period problem of depression. Therefore, he made the specific assumption of short-period so as to concentrate on the problem at hand. Keynes assumed that the techniques of production and the amount of fixed capital used remain constant in the model of his theory. In his view, short period is that in which new investments do not change the technique, the organization and equipment. This considerably simplified his analysis, for he could thereby take employment and output as moving together in the same direction.
(2) Perfect Competition:
He assumed that there is a fairly high degree of consumption in the markets. Or if there is some monopoly element somewhere, then its degree remains unchanged.
(3) Operation of Diminishing Returns:
Further, directly flowing from his assumption of unchanging techniques was his a assumption of the operation of diminishing returns to productive resources or increasing costs.
(4) Absence of Governmental part in Economic Activity:
The government is assumed to play no significant role either as a taxer or as a spender. He ignored the fiscal operations of the government in his analysis to highlight the causes of and remedies for instability of the pure capitalist economy.
(5) A Closed Economy:
Keynes further assumed that the Economy under analysis is a closed one; that is, he did not explicitly recognise in his analysis the influence of exports and imports. This considerably simplified his work.
(6) Static Analysis:
The ‘General Theory’ does not trace out the effect of the future on the present economic events clearly. Its analysis remains comparatively static, though at times Keynes introduced expectations in his analysis.
Keynes states that increase in employment depends on increase in aggregate demand. Aggregate demand increases though increase in investment, increase in government expenditure and so on. So, demand is much more important in Keynesian theory. Effective demand is said to exist at the point where aggregate demand is equal to aggregate supply. According to Keynes, in the short-run, the determination of the level of employment and income depends upon the effective demand of goods. His theory is built upon the basic idea of ‘Effective Demand’ which determines employment. The effective demand in turn depends upon consumption and investment, which depends upon marginal efficiency of capital and the rate of interest.