THE THEORY OF EMPLOYMENT

John Maynard Keynes

Reporter: Rubelyn C. Padillo
 Bibliography

• The greatest and the most eminent economist

of the mid-twentieth century.
• His famous book “General Theory of
employment, interest and money” published
in 1936” challenged the validity of the classical
theory of employment.
• Criticized the classical theory of income and
wealth.
• Propounded new theory of employment and
output Keynesian Revolution
• Keynes advocated many concepts like John Maynard
Propensity to Consume, Multiplier, Marginal Keynes
Efficiency of Capital and Liquidity Preference.
 Keynesian Theory of
Employment and Income
Short period where:
• Stock of capital techniques of production;
• Efficiency of labor; Assumed
to remain
• Size of population; and constant

• The amount of employment depends upon the

level of national income and output.
 lack of effective demand/deficiency of
Unemployment outlay on consumption and investment
function

Level of
income and depends upon the effective aggregate
employment demand
 The Keynesian Theory of
Employment
• Touches all aspects of the economy as a whole
and hence his theory can be called macro
economics.
• National income determined the level of
employment
Greater the national income
 higher will be the level of employment
Lower the level of national income
 the lower the amount of employment.
 Keynesian concepts

1. Fundamental Equation
2. Principle of Effective Demand
3. Consumption Function
4. Marginal Efficiency of Capital (MEC) and
rate of interest
 1. Fundamental Equation

 The fundamental equation of Keynes is

Y=C+I
Y = National Income
C = Consumption
I = Investment
 According to Keynes, the level of national income
determines the level of employment.
 If NI increases, the level of employment could also be
increased.
 So that, increasing the level of NI employment also
increases and thereby the economy should be move from the
under-employment to full employment condition.
2. Constituents of National Income
1. Consumption
2. Investment
3. Expenditures
Government expenditure plays a dominant role
and according to Keynes formula:
Y=C+I+G
Y = National Income
C = Consumption
I = Investment
G=Government
Expenditure.
Total Income
– depends on total employment – this depends on
effective demand in the economy
Effective demand
– depends on consumption expenditure and
investment expenditure.
Consumption
– depends on income and propensity to consume
Investments
– depends on Marginal Efficiency of Capital (MEC)
and rate of interest.
 3. Principle of Effective Demand

Effective Demand
– The point at which aggregate demand will be equal to
aggregate supply.
– Equilibrium point determined by the equality of
aggregate demand function and aggregate supply
function.
– According to Keynes, effective demand is equal to
the total volume of output available in the economy
– Therefore, an increase in the output of the economy
is possible only if there is an increase in employment.
4. The Propensity to Consume
• The amount of income which is spent on
consumption out of a given total income is
known as propensity to consume.
• Consumption is one of the important
determinants of level of employment.
• According to Keynes, consumption depends on
two factors size of income and propensity to
consume.
 5. Marginal Efficiency of
Capital (MEC)
• Refers to the expected profitability of an
additional capital asset.
• Defined as the highest rate of return over
cost expected from the marginal or
additional unit of capital asset.
Effective Demand major components:
Consumption
Investment
 6. Rate of Interest
• The rate of interest is determined on the liquidity
preference of the people.
• Liquidity preference is governed by transaction
motive, precautionary motives and speculative
motives.
• The supply of money and the liquidity preference
together determine the rate of interest.
 Investment function
• Crucial factor in the determination of effective
demand.
• Investment demand depends upon two factors
MEC and rate of interest.
• Rate of interest is comparatively stable and
does not frequently change in the short run.
• Therefore, the fluctuations in the level of
investment depends on MEC.
 2 Types of Investments
1. Induced Investment
– investment expenditures by the business sector that
are based on the level of income or production.
2. Autonomous Investment
– an investment which does not change with the changes in
the income level – independent of income.
– depends more on population growth and technical
progress than on the level of income.
– Most of the autonomous investment undertaken by
government – at time of depression enhancing aggregate
demand.