Keynes Theory of Income and Employment Essay

The term ‘classical economists’ was firstly used by Karl Marx to describe economic thought of Ricardo and his predecessors including Adam Smith. However, by ‘classical economists’, Keynes meant the followers of David Ricardo including John Stuart Mill, Alfred Marshal and Pigou. According to Keynes, the term ‘classical economics’ refers to the traditional or orthodox principles of economics, which had come to be accepted, by and large, by the well known economists by then. Being the follower of Marshal, Keynes had himself accepted and taught these classical principles. But he repudiated the doctrine of laissez-faire. The two broad features of classical theory of employment were: (a) The assumption of full employment of labour and other productive resources, and (b) The flexibility of prices and wages to bring about the full employment (a) Full employment:- According to classical economists, the labour and the other resources are always fully employed. Moreover, the general over-production and general unemployment are assumed to be impossible. If there is any unemployment in the country, it is assumed to be temporary or abnormal. According to classical views of employment, the unemployment cannot be persisted for a long time, and there is always a tendency of full employment in the country. (b) Flexibility of prices and wages:- The second assumption of full employment theory is the flexibility of prices and wages. It is the flexibility of prices and wages which automatically brings about full employment. If there is general over-production resulting in depression and unemployment, prices would fall as a result of which demand would increase, prices would rise and productive activity will be stimulated and unemployment would tend to disappear. Similarly, the unemployment could be cured by cutting down wages which would increase the demand for labour and would stimulate activity. Thus, if the prices and wages are allowed to move freely, unemployment would disappear and full employment level would be restored. Say’s Law:- 1. Say’s Law is the foundation of classical economics. Assumption of full employment as a normal condition of a free market economy is justified by classical economists by a law known as ‘Say’s Law of Markets’. 2. It was the theory on the basis of which classical economists thought that general over-production and general unemployment are not possible. . According to the French economist J. B. Say, supply creates its own demand. According to him, it is production which creates market for goods. More of production, more of creating demand for other goods. There can be no problem of over-production. 4. Say denies the possibility of the deficiency of aggregate demand. 5. The c onceived Say’s Law describes an important fact about the working of free-exchange of economy that the main source of demand is the sum of incomes earned by the various productive factors from the process of production itself. A new productive process, by paying out income to its employed factors, generates demand at the same time that it adds to supply. It is thus production which creates market for goods, or supply creates its own demand not only at the same time but also to an equal extent. 6. According to Say, the aggregate supply of commodities in the economy would be exactly equal to aggregate demand. If there is any deficiency in the demand, it would be temporary and it would be ultimately equal to aggregate supply. Therefore, the employment of more resources will always be profitable and will take to the point of full employment. 7. According to Say’s Law, there will always be a sufficient rate of total spending so as to keep all resources fully employed. Most of the income is spent on consumer goods and a par of it is saved. 8. The classical economists are of the view that all the savings are spent automatically on investment goods. Savings and investments are interchangeable words and are equal to each other. 9. Since saving is another form of spending, according to classical theory, all income is spent partly for consumption and partly for investment. 10. If there is any gap between saving and investment, the rate of interest brings about equality between the two. Basic Assumptions of Say’s Law:- (a) Perfectly competitive market and free exchange economy. (b) Free flow of money incomes. All the savings must be immediately invested and all the income must be immediately spent. (c) Savings are equal to investment and equality must bring about by flexible interest rate. (d) No intervention of government in market operations, i. e. , a laissez faire economy, and there is no government expenditure, taxation and subsidies. (e) Market size is limited by the volume of production and aggregate demand is equal to aggregate supply. (f) It is a closed economy. The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s. It was the longest, most widespread, and deepest depression of the 20th century. In the 21st century, the Great Depression is commonly used as an example of how far the world’s economy can decline. The depression originated in the U. S. , starting with the fall in stock prices that began around September 4, 1929 and became worldwide news with the stock market crash of October 29, 1929. From there, it quickly spread to almost every country in the world. The Great Depression had devastating effects in virtually every country, rich and poor. Personal income, tax revenue, profits and prices dropped. Unemployment in the U. S. rose to 25%, and in some countries rose as high as 33%. British economist John Maynard Keynes argued in General Theory of Employment Interest and Money that lower aggregate expenditures in the economy contributed to a massive decline in income and to employment that was well below the average. In such a situation, the economy reached equilibrium at low levels of economic activity and high unemployment. Keynes’ basic idea was simple: to keep people fully employed, governments have to run deficits when the economy is slowing, as the private sector would not invest enough to keep production at the normal level and bring the economy out of recession. Keynesian economists called on governments during times of economic crisis to pick up the slack by increasing government spending and/or cutting taxes. Criticism of Keynes on Classical Theory:- The law of J.B Say was finally falsified and laid to rest with the writings of Lord J.M. Keynes. He in his book, General Theory, has severally citicized the Say’s La on the following grounds. †¢ Posibility of defficiency of affective demand:- He says that in a compatative market it is not necessory that all income earned is automatically spend on cosumption and investment. A part of Income may be saved and may go to increase individual holdings. There may, thus appear a deficiency in aggregate demand causing overproduction and unemployment in the country. †¢ Pigou’s view on wage cuts:- Keynes criticized the view that a general cut in real wages in times of depression is a cure for unemployment. Keynes is of the view that a general cut in real wages may reduce the aggrigate demand for goods and deepen depression. †¢ Saving investment equality:- The Say’s Law assumes that micro economic analysis can profitably by by applied to the economy as a whole. Keynes rejects this view and says that for the explanation of the general theory of income and employment, the macro economic analysis is required. †¢ Saving investment equality:- Keynes was never convinced of the classical version that interest elasticity can equate savings ad investment. According to him, It is the income not the rate of interest which is the equilibrium force between saving and investment. †¢ Monopoly element:- Say’s Law assumes perfect competition in the economy. Keynes says It is the imperfect completion which in practice prevails in the product and factor market. †¢ Role of Trade unions:- In the contemporary capitalistic world, The trade unions bargain with the employers for the fixation of wages. The state also fixes minimum wages in certain industries. †¢ Short run economics:- Keynes says that, the lenth of long run is not clear in Say’s law. Keynes Theory Of Income And Employment John Maynard Keynes wrote his esteemed book â€Å"General Theory of Employment† in 1936. Keynes has strongly criticised the classical theory in his book. His theory of employment is widely accepted by modern economists. Keynesian economics is also known as ‘new economics’ and ‘economic revolution’. Definition:- â€Å"In short period, level of national income and so of employment is determined by aggregate demand and aggregate supply in the country.† â€Å"Volume of employment depends on the level of national income and output. Increase in national income means increase in employment† The equilibrium of national income occurs where aggregate demand is equal to aggregate supply. This equilibrium is also called effective demand point.