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Distinguish between Classical Theory and Keynesian Theory of income and employment. Further, Keynes failed to consider the influence of price expectations on the demand for money. Keynes, on the other hand, adopted the macro approach to economic problems. In this field, as opined by Mrs. Robinson, “Keynesian revolution commands the field.”. Most of the modern economists agree with the concept of Keynes. (f) Lastly, the Keynesian economics fails to provide solutions to a number of socio-economic problems facing the developed countries. Prof. Harry John Son wrote in 1961, “At this date there is no need to labour the point that the General Theory deserves much of the credit for the fact that the maintenance of high and stable employment is now accepted as a governmental responsibility, or that Keynes’s theory of effective demand is the origin of the modern theory of economic policy.”. He was thus a practical economist whose models clarify both inflationary and deflationary episodes, and prosperous and depressed economies. Such problems include fair employment, income distribution and resource allocation. The main elements of the General Theory can be found embryonic form in the works of his predecessors but Keynes’s novelty lies in giving them a new complexion. Since it is measured by total expenditure of the community on goods and services, therefore, aggregate demand also means aggregate expenditure on final goods and services in the economy. Keynes attacked not the logical consistency of the classical economic theory, but its empirical premises. Copyright 10. Consumption function shows the mathematical relation between income and consumption i.e. Income and employment theory, a body of economic analysis concerned with the relative levels of output, employment, and prices in an economy. (ii) Flexibility of prices and wages. Therefore, Classicals advocated for a free economy. Classical economics was founded by famous economist Adam Smith, and Keynesian economics was founded by economist John Maynard Keynes. It means that the cyclical upward and downward movement of employment and output adjust by itself. Say's Law of Market. Further, Keynes neglected the relationship between capital stock and investment. This makes Keynes’s analysis unrealistic. According to them: "Unemployment results when there is an excess supply of labor at a particular higher wage level. Keynes, on the other hand, integrated monetary theory and value theory. The demand for labors and other factor resources are determined by the demand for the products in the market. Delhi - 110058. product, labour and money. According to Prof. Burns, the determination of Keynes’s theory in terms of effective demand “reflects a pleasant but dangerous illusion.”. In order to maximize their profit, firms employ factors of production to the point where margi… © He also brought interest theory into the domain of monetary theory. The theory is based on the assumption of long-run full employment equilibrium. He accepted the classical theory, criticised and extended it and at the same time rejected parts of it. Disclaimer 9. As Prof. Hazlitt opines, “Inflation is at once an uncertain remedy for unemployment and unnecessary remedy for unemployment. Thus increase in demand has led to increase in output, employment and income. Prohibited Content 3. There is no possibility of under-employment equilibrium in the long-run. The core issue of macroeconomics is the determination of level of income, employment and output. Thus income or total output measures the aggregate supply of goods and services.Aggregate Supply = Output = IncomeA major portion of income is spent on consumption of goods and services and the balance is saved. Classicists are focused on achieving long-term results by allowing the free market to adjust to short-term problems. The classicists believed that saving and investment were equal at the full employment level and in case of any divergence the equality was brought about by the mechanism of rate of interest. As income increases, 75% of, additional income is spent on consumption. (ii) Demand creates its own supply: Aggregate demand for goods and services directly determines the level of output, income and employment. Keynesian Theory was given by Keynes when in his volume “ General Theory of Employment, Interest, and Money ” had not only criticized the Classical Theory of Employment but had also analyzed those factors that affect the employment and production level of an economy. Economists have criticised the Keynesian analysis of wages and employment. First, for taking the aggregate supply to be stable as noted above. According to Keynes "Aggregate supply is perfectly elastic with respect to prices till the full employment level of output is reached.").Fig. Keynesian economics is a theory that says the government should increase demand to boost growth. Meaning of Consumption Function. His notion of underemployment equilibrium is indeed revolutionary and has stood the test of the time. In the Keynesian system money in neutral in situations of full employment and liquidity trap (when the rate of interest becomes inelastic in a depression). So aggregate demand should be raised in order to raise level of employment. Another criticism of the Keynesian economics is that it is applicable to the short-run. Classical theory is the basis for Monetarism, which only concentrates on managing the money supply, through monetary policy. (b) Keynes’s favoured public investment to overcome depression and to attain full employment. According to Keynes:(i)    An economy can be in equilibrium at less than full employment level Economic system does not ensure automatic equilibrium at full employment as believed by Classicals. Thus total consumption (C) comprises two components (i) Autonomous Consumption, influenced by income, and (ii) Induced Consumption (bY) influenced by income. However, they have given a number of assumptions. However in this essay we will see it from another perspective: Prof. Ackley calls the Keynesian model as “too static.”. When money wages are very high, there will be unemployment on the principle that when the price of any commodity is very high, the whole of it will not be sold.” Patinkin’s argument is more convincing “that a deficiency in commodity demand can generate a decrease in labour input without requiring a priori increase in real wage rate.”, Keynes has also been criticised for his analysis of business cycles which was primarily based on expectations. For, example, the consumption equation C = 30 + 0.75 Y means र 30 is autonomous, consumption which is incurred without having any income. He was a dunce. It was Keynes who led vigorous and … 4. Thus 45° line (also called a Guideline) helps us to identify equilibrium when two variables are to be shown graphically equal,(Classical and Keynesian concepts of Aggregate Supply. Equilibrium level of income and employment is established at a point where AD = AS. The ideas he advanced were his own even though someone else may have expounded the same or similar ideas at an early date.”. Income provides employment. Keynesian Model 9. Keynes also did the same thing. Despite Samuelson’s severe denunciation of the General Theory as a “badly-written book, poorly organised…not well-suited for classroom use…arrogant, bad tempered, polemical, not overly generous in its acknowledgements and abounding in meads and confusions,” it still remains the most popular treatise on economics whose technical apparatus has been absorbed into the general body of economics. Its main tools are government spending on infrastructure, unemployment benefits, and education. He was a profound thinker. In the General theory of employment, interest, and money, Keynes disagreed with the Classical notion that: a market economy is self-regulating and always automatically moves to macroeconomic equilibrium at the full employment level of real GDP For instance, it is possible to achieve full employment even when the effective demand is low, provided wage-rates are so flexible that they could be adjusted quickly to the prices. 2020 Zigya Technology Labs Pvt. Thus Keynes failed to incorporate the real forces determining the interest rate. We know that money value of final output is distributed as rent, wages interest and profit among factors of production who help produce the output. In case of Temporary situation of unemployment, a cut in money wage increases employment. There is “money illusion” in the Keynesian speculative demand for money which means that the increased supply of money is absorbed only at a lower rate of interest. Thus Keynes makes the saving-investment relationship very confusing. It is because the level of aggregate supply is constant during short period. JEL Classification: B10, B11, B12, B15, B22, E12, E65, N10. The critical evaluation of Keynesian economics reveals that there are the Keynesians who eulogise Keynes and there are the anti-Keynesians like Hazlitt who “could not find a single doctrine that was both true and original.”, On the other hand, Keynes’ greatest follower Dillard writes, “Keynes was an original thinker in the sense that he arrived at his ideas in his own way. Keynes found that the classical economics provided no solution to the actually prevailing problem of wide-spread unemployment during the Great Depression of 1930s. The classical analysis was based on Say’s Law of Markets that “supply creates its own demand.” The classicists thus ruled out the possibility of over production. In short, consumption equation, Consumption (C) at a given level of income (Y) is equal to autonomous. They, therefore, never thought it necessary to have a special theory of employment. This is the gist of Keynesian or Macro approach. In fact, aggregate demand in the economy is the driving force that determines the level of output, employment and income. For this, they have to determine the level of output to be produced and the number of workers to be employed. Each theory has a different approach to the economic study of monetary policies, consumer behaviors, and government spending. how much of income is spent on consumption goods. Theory of Income and Output 8. Keynes did not pay as much importance to saving as to investment in his analysis. There has been a public debate in the academic journals among the economists on the occasion of the twentieth and twenty-fifth anniversaries of the publication of the General Theory; in fact right from its publication, as to whether it is evolutionary or revolutionary. 3. To Keynes, saving was a private virtue and a public vice. The basic assumptions of the theory include: Supply creates its own demand. The extent to which an economy moves naturally towards equilibrium without the interference of government, is the subject of intense debate in economics and has been so since its origins. CHAPTER 5: OUTPUT-EMPLOYMENT THEORIES (CLASSICAL AND KEYNESIAN) 5.1 Classical Theory (A) Introduction: Employment and output analysis at macro level has become an important part of economic theory only during and after the Second World War period. Around the turn of the present century, the world witnessed a series of crises which cast doubt on the practical utility of the orthodox economics. Keynes erred in depending exclusively on the investment function and taking the consumption function to be stable in determining the volume of employment. Consumption level C = 300 + 5/10 x 1000 = 300 + 500 = र 800 crores. It portrays the economy as a free-flowing, with prices and wages freely adjusting to the ups and They advocated for a full-employment labor market. Keywords: Classical, Keynesian, economics, theories, policy, debate, implications. The classical economists failed to provide an adequate explanation of the cyclical phenomena. The Classical Theory of Income and Employment is premised on three conjectures. Hence there is neither general over-production nor unemployment. The classical economics was a microeconomic analysis which the orthodox economists tried to apply to the economy as a whole. For instance, the principle of effective demand states that when the aggregate demand curve is over the aggregate supply curve, the entrepreneurs employ more labourers in expectation of earning larger profits till the point of effective demand is reached. Keynesian Theory of Income and Employment: Definition and Explanation: John Maynard Keynes was the main critic of the classical macro economics. Under-employment equilibrium is a normal situation while full employment equilibrium is an ideal and special situation. At the given price level, output can be increased till all the resources are fully employed.If we go deep, we will find aggregate supply is represented by national income. Prof. Harris regards Keynes’s views on wages and employment as revolutionary. J. M. Keynesian theory is a general theory. Keynes has been criticised for his over emphasis on expectations. Another weakness of the Keynesian theory is that it is based on the unrealistic assumption of perfect competition. Not only that the kind of full employment as envisioned by classical economists could never be attained by any country (at least it is not documented) there occurred a severe depression in West Europe, UK in particular, and USA during 1873 - 1897. (d) Keynes paid little attention to monetary policy. But still the efficacy of classical theory in guiding public policy could not be successfully Let us, therefore, start with the meaning of aggregate demand (AD). Effective demand is derived from the actual household disposable incomes and not from the disposable income that could be gained at full employment, as the classical theories state. Individuals are price takers, … The core issue of macroeconomics is the determination of level of income, employment and output. The theory is based on the belief that "supply creates its own demand” which implies that whole of output is demanded and sold out. They believe that; An economy, as a whole, always functions at the level of full employment i.e., full employment of labour and other resources . Keynes thus advocated public spending instead of public saving to remove unemployment. 5. Keynes theory were widely accepted and provided the basic foundation for the modern theory of employment. Expectations breed uncertainty. Classical economics places little emphasis on the use of fiscal policy to manage aggregate demand. Ltd. Download books and chapters from book store. Theory of Income and Output 8. According to Patinkin, “This line of reasoning is yet another fallacious by-product of the usual Keynesian neglect of the supply side of the commodity market.”. Few would gainsay that Keynes “opened up new vistas and new pathways to a whole generation of economists,” but many would now consider his analysis less than adequate for meeting such special problems as cyclical forecasts and controls, persistent inflation, the maintenance of full employment, booms, secular growth, non-linear structural relations and macro-functional distribution. The classicists artificially separated the monetary theory from the value theory. Keynes also suggested increase in money wages or reduction of real wages to remove unemployment. Thus the Keynesian theory is divorced from reality. This weakness stems from his efforts to formulate a pure monetary theory of interest and his rejection of the Wicksellian natural rate of interest. (b) Keynesian theory of employment. But he was wrong because it is also interest elastic though at high interest rates. Variables 5. Advocated government intervention to bring about equilibrium between AD and AS through monetary and fiscal measures and to ensure full employment and its continuity. Their conviction in wage flexibility. In short, consumption equation  shows that Consumption (C) at a given level of income (Y) is equal to autonomous consumption  times of given level of income. But as pointed out by Professor Harris, “It is a matter of judgement whether the General Theory is simply classical economics further developed or embroidered, or whether Keynesian economics represents a genuine break.”. Keynes "The General Theory of employment, Interest and Money" published in 1936. Introduction to Keynesian Theory: Keynes was the first to develop a systematic theory of employment in his book. Privacy Policy 8. For example, the consumption equation C = 30 + 0.75 Y means र 30 is autonomous consumption which is incurred without having any income. by degree of elasticity of supply.”. Calculate consumption level for Y = र 1000 crores if consumption function is C = 300 + 0.5Y. CRITICISM OF KEYNESIAN THEORY 3. There are two main assumptions of classical theory of employment, namely, assumption of full employment and flexibility of price and wages.Let us study these two broad features in detail. But this policy has serious repercussions, because the state may spend beyond its means in an extravagant manner. Elements Labor Demand Vertical Labor Supply Positive Wage equation Negative Prices Constant Key Measures Lower Interest Rate, increase aggregate demand Elements Labor Demand Negative Labor Supply Positive Wage equation Positive Prices Variable Key Measures Real wage moderation, lower subsidies and pay … Determination of Equilibrium Level 7. As pointed out by Hicks, “The theory of the acceleration and the theory of multiplier are the two sides of the theory of the fluctuations, just as the theory of demand and the theory of supply are the two sides of the theory of value.”. He put forth a general theory of employment applicable to every capitalist economy. If aggregate demand increases, level of output will increase to meet the increased demand. “The relationship does not run simply from current income to current consumption,” as Keynes forged, rather it “involves some complex average of past and expected income and consumption,” as pointed out by Professor Ackley. Though Keynes gave a dominant role to expectations in influencing the marginal efficiency of capital, yet he failed to formulate a precise theory of expectations. The classical theory assumed the prevalence of full employment. “Viewing Keynes’s theory as a whole, its revolutionary nature lies,” according to Prof. Dillard, “in the repudiation of any presumption in favour of laissez-faire.”. (a), 232, Block C-3, Janakpuri, New Delhi, It is ex-ante saving that is more important in influencing the level of employment. Thus aggregate demand is synonymous with aggregate expenditure in the economy. Yicheng Wang, Can Wage Dynamics in Long-term Employment Relationships Help Mitigate Financial Shocks, SSRN Electronic Journal, 10.2139/ssrn.2438252, (2015). Classical economics places little emphasis on the use of fiscal policy to manage aggregate demand. The theory is ascribed to early Classical economists like Adam Smith, Ricardo, and Malthus and neo-classical like Marshall, Pigou and Robbins. Having discussed the two theories in the foregoing pages, we can now make the following comparison: Classical Theory Keynesian Theory 1 Equilibrium level of income and employment is established only at the level of full employment. Unemployment results from the deficiency of effective demand because people do not spend the whole of their income on consumption. It was J. M. Keynes who first analyzed the frequent problem of unemployment and fluctuating levels of real output or national income. The classical economists being the votaries of lassie-faire policy had no faith either in fiscal policy or monetary policy. Classical theory is the basis for Monetarism, which only concentrates on managing the money supply, through monetary policy.Keynesian economics suggests governments need to use fiscal policy, especially in a recession. Keynes’ real contribution to the business cycle analysis lies in his explanation of turning points of the cycle and in the change of attitude as to what should and should not be done by the government to control the cycle. Those theories are Keynesian and Classical. They believed in the balanced budget policy. He wrote several books. Economy by itself brings about full employment equilibrium through flexible system of interest rates, wages and prices. Moreover, Keynes failed to recognise that saving is not hoarded but spent on both consumer and capital goods. What do you understand by aggregate demand (AD)? The pure, unadulterated capitalism of the classical ideology could not function because as Keynes wrote, “It is not intelligent, it is not beautiful, it is not just, it is not virtuous and it does not deliver the goods.”, Keynes reformed capitalism by advocating the necessity of state intervention in order to increase aggregate demand and employment and thus saved it from giving way to communism. This was a useful simplification in the pioneering days of the theory…but there is no such thing as the rate of interest and that the demand and supply of every type of asset has just much right to be considered as the demand and supply of money.”. Keynes, a British Economist propounded his own theory and in 1936 brought out his famous book, "General Theory of Employment, Interest and Money," which brought about a revolution in economic thought. As a result, employment and income will also rise. Since there is no taxation, all personal income will become not reusable income. Keynesian Theory of Income and Employment! Keynesian Theory of Income and Employment! Policy Implications 10. The classical economists did not propound any particular theory of employment. In other words, AD is the total expenditure which all sectors of economy are willing to make on purchase of goods and services. Keynesian economics suggests governments need to use fiscal policy, especially in a recession. Hence the question of the applicability of Keynesian theory in them does not arise. Full employment … Put in the form of an equation:AS = C + SClearly aggregate supply has two components, namely, consumption expenditure and savings. Introduction The Classical Model was prevailing with full popularity before the Great Depression of 1930. (b) Keynesian Theory of Income and Employment. Thus the General Theory was born in a favourable environment and was characterised by economists like Harris as “The New Economics” and by others as revolutionary or evolutionary. Advocated policy of laissez faire and opposed government intervention since equilibrium is established automatically by market forces of demand and supply. Fiscal Policy. Market force of demand and supply determine the level of prices in the economy. Variables 5. Keynes regarded his theory dynamic and called it “the theory of shifting equilibrium.” Even his foremost pupil Roy Harrod calls him “the father of dynamic economics.” Keynes introduced an element of dynamism in his theory through the ‘expectations.’ But his analysis was concerned with the level of employment at any time. As a result demand for labour would continue to rise until unemployment is removed from the labour market. Policy Implications 10. “The unit of analysis must be the individual commodity or commodities grouped in some other manner, e.g. Say's Law of Market. Thus the direct relationship between effective demand and the volume of employment is fallacious. Some numericals for further clarification are given below. Its two features are noteworthy. To Klein, “The revolution was solely the development of a theory of effective demand,” and to Hansen, “Consumption function is an epoch making contribution to the tools of economic analysis.”. The book revolutionized macro economic thought. He proved that an economy could be in equilibrium even at less than full employment level. Keynesian vs Classical Theory of Unemployment An approach to the Spanish labor market. This made his theory of business cycles one-sided because his explanation centres round the principle of multiplier. Prices, wages and interest rates may not be flexible due to presence of monopolies and trade unions. (e) Keynes’ policy measures fail to tackle the problems of capital formation and growth which result from technological innovations. He did not offer any solution to frictional unemployment and technological unemployment. wages and prices are assumed to be flexible downwards. TOS 7. And according to Dillard, “The acceptance of deficit financing as a respectable type of public policy is one of the remarkable changes in public thinking for which Keynesian economics has been primarily responsible.” We therefore, do not agree with Hazlitt, the staunch anti-Keynesian that the General theory was “one of the great intellectual scandals of our age.” In fact, Schumpeter’s assessment of Malthus applies fairly to Keynes. Moreover, Keynes ignored what Patinkin calls the “direct influence of real-balance effect on aggregate demand.” When the wealth of the people increases, it affects consumption and hence the demand for money. Keynes’s treatment of the speculative demand for money is very narrow because he confined himself only to cash and bonds, and failed to consider other types of assets. Most of the modern economists agree with the concept of Keynes. mechanism to adjust employment anymore but labor demand does. But Keynes opposed such a policy both from the theoretical and practical points of view. Two important theories of income and employments are : 1. Introduction to Keynesian Theory: Keynes was the first to develop […] https://www.zigya.com/share/RUNFTjEyMDUxMzk4. Before the Great Depression, economists believed that free markets always produced the best results. Sufficient market exists for all the produced goods and services. For example, suppose that the economy is going through a downturn so the demand in the market has fallen. Keynes attacked the classical doctrine for its failure to solve the economic problems of the modern world. not everything produced will necessarily be purchased. Thus there is divergence between the point of equilibrium attained by an economy and the point of equilibrium at which an economy has full employment of resources. 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Perfect competition it needs to be flexible downwards but higher taxes on companies may consumption! The field. ” if communism comes, Keynes neglected the relationship between aggregate income and employment is premised three...

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