Variables of the Theory:

The variables used by Keynes in his theory

can be broadly divided into three groups:

1. Given Elements:

First there are variables which have been

assumed as given because they change so slowly
that their effects in short run can be ignored.
They are- (a) the quality and quantity of labour
and capital stock; (b) techniques of production;
(c) degree of competition; (d) consumer tastes;
(e) the structure of the society.

2. Independent Variables (or Causes):

Independent variables are the behaviour

patterns of the society. In other words, they
represent the basic functions or relationships.
- ·1·nere are four independent variables:

(i) The consumption function;

(ii) The investment function or the marginal

efficiency of investment schedule;

(iii) The liquidity preference function;

(iv) The quantity of money fixed by the

monetary authority.

All these variables are stated in wage units.

3. Dependent Variables (or Effects):

The dependent variables of the Keynesian

system are- (a) the level of employment, output
and income, and (b) the rate of interest. Keynes
makes rate of interest an independent variable.
But, according to Hansen, rate of interest is a
determinate, and not a determinant. Rate of
interest along with national income together are
mutually determined by the above mentioned
four independent variables.
~uI0111ary of Keynesian Theory of
E111ploy111ent:
Keynesian theory of employment, as developed
in the General Theory is outlined in Chart-1.

The main propositions of the theory are

given below:

(i) Total employment = total output = total

income. As employment increases, output and
income also increase proportionately.

(ii) Volume of employment depends upon

effective demand.

(iii) Effective demand, in turn, is determined by

aggregate supply function (representing costs of
entrepreneurs) and aggregate demand function
(representing receipts of entrepreneurs). It is
determined at the point where aggregate
demand and aggregate supply are equal.
(iv) Keynes assumed aggregate supply function
as given in the short period and regarded
aggregate demand as the most important
element in his theory.
consumption expenditure and investment
expenditure.

(vi) Consumption expenditure depends upon the

size of income and the propensity of consume.
Consumption expenditure is fairly stable in the
short-period because propensity to consume
does not change quickly.

(vii) Investment expenditure is governed by

marginal efficiency of capital (i.e., profitability
of capital) and the rate of interest. Unlike
consumption expenditure, investment
expenditure is highly unstable.

(viii) The marginal efficiency of capital is

determined by the supply price of capital assets
on the one hand and the prospective yield on
the other. Prospective yield, in turn, depends
upon future expectations. This explains why the
marginal efficiency of capital and hence
investment expenditure fluctuates.
(ix) Rate of inte rest is a mon etar y phe nom eno n
and is dete rmin ed by the dem and for mon ey
(liquidity preference) and the qua ntit y of
money. Liquidity pref eren ce dep end s upo n thre e
motives- tran sact ion motive, prec auti ona ry
motive, and spec ulat ive motive. Qua ntity of
mon ey is regu late d by the mon etar y auth ority .

(x) The essence of the who le theo ry of

emp loym ent is that emp loym ent( = outp ut=
income) dep end s upo n effective dem and .
Effective dem and exp ress es itsel f in the who le
of tota l spen ding of the community, i.e.,
con sum ptio n exp end itur e and inve stm ent
exp end itur e.

A fund ame ntal prin cipl e is that as inco me of the

com mun ity increases, con sum ptio n will

increase, but by less than the incr ease in
income. Thus, in order to increase the level of
employment, investment must be increased.
Investment must be high enough to fill the gap
between income and consumption.

(xi) Original Keynesian analysis considers

private consumption and private investment
expenditure only and does not take into account
government expenditure. But, in modem times,
government expenditure is also a significant
determinant of effective demand. Government
expenditure is considered the most effective
weapon to fight unemployment.