The General Theory of Employment, Interest and Money is a book by English economist John Maynard Keynes, first published in 1936. The book attempts to explain why unemployment can remain high long after a recession is over, and argues that the level of employment is determined not by the price of labour, but by the level of aggregate demand. It caused a shift in economic thought when it was published, and brought about what is called the Keynesian Revolution - putting macroeconomics at the heart of economic theory. Covering subjects such as consumerism, investment, wages, and prices, Keynes' book was equally praised and criticised and in 2011 the book was placed on Time's top 100 non-fiction books.
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Many people have studied Keynesian Economics for an interest, studied AP economics or took college classes. Students might even be able to give the pros and the cons, yet never actually read anything by Keynes. Legions of economic students, even at the graduate level are immersed in Keynesian theory, yet have never read one word of the actual writings of John Maynard Keynes.
Keynes was the first to develop a systematic theory of employment in his book. The General Theory of Employment, Interest and Money (1936). The classical and the neoclassical economists almost neglected the problem of unemployment.
They regarded unemployment as a temporary phenomenon and assumed that there is always a tendency towards full employment. It was Keynes who led a vigorous and systematic attack on the traditional theory of employment and replaced it with a more general and more realistic theory.
(i) It is general theory in the sense that- (a) it deals with all levels of employment, whether it is full employment, widespread unemployment or some intermediate level; (b) it explains inflation as readily as it does unemployment, because basically both situations are a matter of volume of employment, and (c) it relates to changes in the employment and output in the economic system as a whole.
(ii) Keynesian theory of employment is a short-run theory which attempts to analyse the short-run phenomenon of unemployment. He assumed constant all those strategic variables which remain stable and change very little in the short-run.
(ix) Rate of interest is a monetary phenomenon and is determined by the demand for money (liquidity preference) and the quantity of money. Liquidity preference depends upon three motives- transaction motive, precautionary motive, and speculative motive. Quantity of money is regulated by the monetary authority.
(x) The essence of the whole theory of employment is that employment (= output = income) depends upon effective demand. Effective demand expresses itself in the whole of total spending of the community, i.e., consumption expenditure and investment expenditure.
Aggregate demand function represents different amounts of money which the entrepreneurs expect to get from the sale of output at varying levels of employment. Or, to put it differently, aggregate demand function reveals planned or intended expenditure at different levels of income.
Aggregate supply function represents different amounts of money which the entrepreneurs must get from the sale of output at varying levels of employment. Or stated in a different way, aggregate supply function represents different levels of income (and thus output and employment) which the entrepreneurs will supply at different levels of expenditures.
(ii) Aggregate supply function (being given in the short period) cannot be manipulated and thus is not of much practical significance. In order to attain full-employment level of ONf (or to remove unemployment NNf), aggregate demand must be raised from AD curve to AD1 curve. Thus, the Keynesian theory of employment may be more properly called the aggregate demand theory of employment.
The Keynesian theory of employment is also called the theory of income and output. The point of effective demand, which gives the equilibrium level of employment, also indicates the equilibrium level of national income and output.
Thus the level of effective demand determines the general level of income, output and employment in a capitalist economy. At the point of effective demand, aggregate supply [i.e., total value of all final goods and services produced (Y)] is equal to aggregate demand [i.e., total planned expenditures on final goods and services (C+I)].
The amount of money which people hold (M) is a function (L) of rate of interest (i) and income (Y). There is an inverse relationship between i and M, but Y and M move in the same direction. L represents liquidity preference function.
Let us start with the initial equilibrium position when income is Y0 (Rs. 6000), the amount of money M0 (Rs. 3000) and the rate of interest is i0 (3%). Y0 curve is the liquidity preference schedule at Y0 income level (Figure-9A). With the rate of interest 3% and income Rs. 6000, consumption will be Co (Rs. 4000). The i0 is the consumption function at 3% rate of interest (Figure-9B).
If, for example C+I is not Rs. 6000 but Rs. 8000, then income will rise to Rs. 8000. How would the system behave in order to reach a new equilibrium position? With income Rs. 8000, liquidity preference function rises to Y1 and, given the quantity of money Rs. 3000, the rate of interest rises to i1 (4%) in Figure- 9A. With the rate of interest 4%, consumption function falls to i1; but because of higher income (Rs. 8000), consumption rises to C1 (Rs 4500) in Figure-9B.
Employment can be increased by increasing the quantity of money (i.e., cheap money policy) because it will reduce rate of interest and increase private investment. But Keynes did not consider cheap money policy as a reliable policy to promote private investment in a situation of depression and unemployment.
(i) Keynesian theory is not a complete theory of employment in the sense that it does not provide a comprehensive treatment of unemployment, (a) It deals only with cyclical unemployment and ignores other forms of unemployment, such as, frictional unemployment, technological unemployment, etc. (b) It does not tell us how to secure full and fair employment.
(ii) There exists no direct and determinable relationship between effective demand and volume of employment. It all depends upon the relationship between wage rate, prices and money supply. Moreover, in modern times, most countries are facing the problem of stagflation (i.e., unemployment with inflation).
(ix) It is basically a capitalistic theory. It examines the determinants of employment in a free enterprise economy. Though Keynes has suggested government intervention and controlled capitalism, his theory fails to deal socialist economic system.
(x) Keynesian theory is not applicable in underdeveloped countries. Keynes deals with the problem of cyclical unemployment, whereas the underdeveloped countries face the problems of chronic unemployment and disguised unemployment. 2ff7e9595c
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