Determination of Equilibrium Level of Employment by the principle of Effective Demand

             The equilibrium level of employment is determined by the interaction of aggregate demand and aggregate supply. The point where the aggregate demand function and aggregate supply function intersect each other is the effective demands. At which aggregate demand price and aggregate supply price are equal to each other. This can be illustrated graphically as follows:

In the figure, AD and AS are aggregate demand and aggregate supply curves respectively. Both of these curves are sloping upward which shows that AD and AS both increases as the level of employment increase. Level of employment is measured along on X-axis and cost and income are measured on Y-axis. The interaction of ‘AD’ curve and ‘AS’ curve determine the effective demand and the actual level of employment at any time. Initially, these curves intersect each other at point E. This point ‘E’ is the point of effective demand. At this point, employment level is ON and cost and revenue are both equal to OR. AT point E, the employment level will be in equilibrium in the economy.

At point E or at effective demand point, AD and AS price will be equal to each other as well as equilibrium level of employment will be determined. But equilibrium at point E may not be the state of full employment. According to Keynes, this equilibrium will be established little lower than the level of full employment. There will be a gap between income and consumption. Thus, it is taken as the point of underemployment equilibrium because at equilibrium point E also the labour equal to NN’ will remain unemployed. Keynes has given the explanation about providing employment to the laborers equal to NN’ which is illustrated graphically below:

According to Keynes at ON level of employment there won’t be perfect equilibrium because there still will be labour equal to NN’ unemployed in the economy. In above given figure (B), labours equal to ON’ will be in search of employment. Although ON level of labours are employed, there won’t be the state of full employment. So, equilibrium at point E will be under-employment equilibrium. The state of full employment will be realised only after the labours equal to NN’ also get employed. For this, suitable situation should be created in economy. If effective demand in the economy is increased, then the employment level will also be increased. For this, Keynes has given importance to aggregate demand function. In above given figure-(B), when aggregate demand increases, AD curve will shift upward to the position AD1. When AD increases from EN to E’N’, then the labours equal to NN’ in the economy will get employed. In the short-run, all labours being employed, the state of full employment will be realised.

From the above discussion we know that effective demand defer mines the level of employment. When effective demand increases, employment level also increases and vice-versa. Thus, unemployment is caused by a deficiency of effective demand. Effective demand represents the total expenditure on total output produced which equals to national income. National income equals to national expenditure. National expenditure consists of expenditure on consumption and investment. Thus, the main determinants of effective demand and level of employment are consumption and investment.

Criticisms of Keynesian Theory of Employment

Keynesian theory of employment is considered as superior to the classical theory, because Keynesian theory of employment is more scientific and practical to classical theory. Despite this, there are many drawbacks in the Keynesian theory of employment. Economists like Miser, Hayck, Knight, K.K. Kurihara, etc, have criticized the Keynesian theory vary strongly. Some of the criticisms are as follows:

(1) Ignorance of micro-economic Theories:

Keynesian theory of employment is based on macroeconomic phenomenon. It neglects interrelationship between micro and macro economics. All the macroeconomic variables are depending on microeconomics. So, the study of macroeconomics will not be completed without the study of microeconomics.

(2) Unrealistic Assumptions:

Keynesian theory of employment is based on the unrealistic assumption of perfect competition, closed economic system and short-run analysis, etc. But in any capitalistic economy, monopoly and oligopoly exists rather than perfect competition. Therefore, Keynesian theory of employment is unrealistic and impractical.

(3) Employment may not always Increase as Investment Increase:

         J.M. Keynes considered that level of income and employment is highly influenced by investment. But in reality, employment level is highly affected by the marginal propensity to consume. But Eeynes, in the short-run has taken marginal propensity to consume as constant. That is, he has not taken the marginal propensity to consume as the factor determining the level of employment.

(4) No direct relationship between employment and effective demand:

         Keynesian theory of employment explains that there is functional relationship between employment and effective demand, i.e., higher the effective demand higher will be the level of employment and vice-versa. But in reality, employment level is highly influenced by supply of money, prices of goods, elasticity of labour and economic development of an economy.

(5) Static in Nature:

            Keynesian theory of employment has not given a thought to time-lags. Keynes was of the view that the consumption would increase as a result of the increase in income. In reality, it is appropriate to take this theory as comparative-static rather than dynamic.

(6) Fundamentally a  capitalistic theory:

Keynesian theory basically examines the determinants of employment in free market economy. Although Keynes suggests government intervention and controlled capitalism, his theory fails to deal with the socialist economic system. Therefore, Keynesian theory is known as capitalistic theory.

(7) Inappropriate in all the economics:

Keynes has taken his theory of employment as the general theory. But, this theory is not applicable in all the countries specially underdeveloped countries. This theory is only applicable in capitalistic countries like England, Japan and America (USA). This theory deals with the problem of cyclical unemployment. But, under developed countries have the problem of chronic unemployment and disguised unemployment. Hence, Keynesian theory of employment is not really general in applicable as he claimed.

Despite these drawbacks the impact of Keynes’ theory has not been able to go completely out of the world and the brain of the economists. This theory is characterized as depression economics because it was the outcome of the ‘Great Depression’ of 1930’s. Likewise, the theory of effective demand of Keynes is regarded as the origin of the modern theory of economic policy.

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