UNIT 9: KEYNESIAN THEORIES OF WAGES AND EMPLOYMENT

Structure
9.01 Introduction
9.02 Learning Objectives
9.03 The Great Depression and Failure of the classical theories
9.04 Aggregate demand
9.05 Aggregate Supply
9.06 Aggregate Supply
9.07 Cyclical Unemployment and Keynes
9.08 Post Keynesian Approach
9.09 Let Us Sum Up
9.10 Key Words
9.11 References and Select Readings
9.12 Check your progress possible Answers

Dear Learner,

Unemployment is a problem that concerns all countries in the world such as during the times
of recession as in 2008. However, growth will not automatically result into trickle down of
benefits to the poor. This will depend to a great extent on the nature of growth-whether
productivity oriented or employment oriented. During times of declining employment, market
will not automatically bring an adjustment. How these problems can be solved? What is the
theoretical basis for the same? What should be the role of the government? How can the role
of the government be understood theoretically? These are some of the questions that we shall
try to answer in this module.

9.01 Introduction

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Unemployment is a problem that concerns policy makers in all countries of the world.
Generation of employment has therefore been an important policy measure that has received
considerable attention in the literature. The classical theories of economic growth emphasised
Say’s Law of market that supply creates its own demand. Accordingly if there are any
imbalances in the economy will be automatically corrected through market mechanism. Over
a period of time product market will be in equilibrium and this will also bring an equilibrium
in the labour market. According to the classicists, unemployment, if any existed was only due
to the market failure. These theories provided no solution to the problems arising due to
business cycles such as those during the period of great depression during the 1930s. This
module will explain how the classical approach failed to solve the problems arising during the
business cycle phase and also that Keynesian approach is completely in contrast to the
classical theories. J.M. Keynes’ has been associated with pump-priming. His writings provide
lessons for the crisis even in the present times. He strongly recommended the use of fiscal
policy during the business cycle phase. He believed that easy monetary policy would not be
helpful in bringing the economy out of economic slump and also that governments can resort
to deficit financing and should borrow to fund public works program.

As for the labour market, Keynes believed that even if unemployed labour attempts a fall in
wages during the period of declining employment, firms will not hire more labour than they
need to produce desired levels of output. According to him, unemployment is not caused by
faulty operation of the labour market like rigid wages but rather unemployment is the result of
insufficient effective demand and can only be resolved by creating more jobs—which in turn
requires higher demand for the output that would be generated by the additional workers. In
other words, unemployment is “normal”, resulting from the operation of market forces, thus,
can be resolved only through purposive social policy well-targeted to raise aggregate demand
and provide jobs for the unemployed.

In view of this, this module deals with the impact of great depression on employment and
Keynesian solution to solve the problem of unemployment. The module also explains the
wage-employment linkages. The concepts such as effective demand, multiplier, deficit
financing, pump-priming, Counter-Cyclical Policies are also discussed in the module. The
emphasis on state’s intervention is also highlighted. The re-emergence of Keynesian concepts
in recent times (Revival of Keynesianism; Keynesian approaches in Contemporary
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Development) through state interventions – such as employment generation and guarantee
programmes – are also highlighted in the module.

9.02 Learning Objectives:

After studying this unit, you will be able to:
Understand about Keynesian theory of wage and employment
Learn about the great depression
Understand the concept of aggregate demand and supply

9.03 The Great Depression and Failure of the classical theories

The publication of the General Theory in 1936 resulted in an outgrowth of the Keynesian
Revolution. The book was a complete divergence from the Classical Theory. Though the
General Theory focussed on depression, the emphasis was on employment.

In orthodox terminology, Full employment meant the full employment of all resources
including capital and raw material as well as labour. It was achieved when there was
maximum output of goods and services irrespective of whether all persons willing and able to
work had jobs or not.

In the classical theory, supply factors play an important role in the determination of output and
employment. An important conclusion of the theory is that the economy is in equilibrium only
at full employment. Unemployment, if any exists, is viewed as a disequilibrium and therefore
only a temporary phenomenon. The classical economists supported their argument that the
situation of full employment would be restored by the market automatically and any
interference by the government will disturb the automatic adjustment mechanism of the
market. The classicists also argued that the level of output would depend on product prices
and also on spending by the households. Any change in the spending would be counteracted
by a proportionate change in the price level. A decline in spending results into decline in
demand for the products that will consequently result into lower prices. In other words,
savings will result into lower prices of the commodities. This will mean that the households
will be able to buy more goods with the given income. Thus, output and employment will not
be affected even with savings. However, this will result in a decline in the demand for labour
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and consequently unemployment. A surplus of labour will therefore be available for work at
the lower wage rates. This will be due to the competition among the workers. The decline in
wages will continue till all the workers are employed resulting into a new lower equilibrium
wage rate. Thus, in the classical model, involuntary unemployment would not exist. This is
because of a perfectly competitive labour market. Thus, in the classical theory interest rate
adjustment mechanism on the one hand and wage- price flexibility on the other hand leads the
economy to a situation of full employment.

According to the classical view, a major cause of unemployment is the rigidity of prices,
especially the prices of the factors of production, which is a part of cost of production. If these
prices are above the natural rate; may be due to monopoly or government support or a
combination then this will result into a distortion of cost-price relationship. This in turn will
restrict output, income and employment. The result would be a downward spiral resulting in
depression. In the classical theory, the prices, which are most inflexible particularly on the
downward side, are wages. Wages constitute largest single item in the cost of production.
Thus, classical economists suggested that wages should be flexible along with the prices of
raw material, capital and products. If prices are flexible enough to adjust easily with changes
in demand, then resources will be utilised and unemployment will be at the minimum. Thus,
high levels of output and employment will be maintained.

John Maynard Keynes

John Maynard Keynes was born on 5 June 1883 in Cambridge. He studied at Eton and also at Cambridge
University, where he studied mathematics. After graduation, he joined civil services and worked in the India Office. In
1909 he was elected a Fellow of King's College and remained so until his death. He was lecturer in Economics from
1911 to 1937 and in 1919 he also accepted the post of Second Bursar of the college.

He served on a number of government committees in the 1920s and 30s, but it was during the two world
wars that he played a significant role in policy decisions. He was the Treasury's representative at the peace conference
that brought an end to the war. At the invitation of the Chancellor of the Exchequer, Keynes placed his services at the
disposal of his country again in 1940, after war had broken out a second time. As an advisor to the treasury, he was
much involved in both the problems of war finance and plans for the later transition from war to peace. Among other
things, Keynes acted as one of the negotiators of Lend-Lease, and played a leading part at the Bretton Woods
conference. Keynes' most popular work, 'The General Theory of Employment, Interest and Money', was published 155in
1936, and became a benchmark for future economic thought. It also secured his position as Britain's most influential
economist, and with the advent of World War Two, he again worked for the treasury. In 1942, he was made a member
of the House of Lords. During the war years, Keynes played a decisive role in the negotiations that were to shape the
post-war international economic order. In 1944, he led the British delegation to the Bretton Woods conference in the
United States. At the conference he played a significant part in the planning of the World Bank and the International
Monetary Fund. He died on 21 April 1946.
 In the classical model, market is a self-regulating system and full employment is the norm.
Prolonged market fluctuations and unemployment would not be a characteristic of the
economy. If at all, it exists, would only be a temporary phenomenon.

Keynesian approach is a complete contrast to the classical theory and Keynes asserted that
market does not have any self-regulating automatic mechanism to ensure full employment.
Inflation and employment according to him are the result of disturbances in the basic
fundamental decisions in the economy along with certain other external factors that cause
economic instability in the economy. There are imperfections in the market and there are
several obstacles, which do not allow flexibility in wages and prices. Even if the wages and
price change downward during the times of recession, this would only mean lower wages and
income. For the economy as a whole, low income of the workers would only result in low
spending on consumption goods. This will keep the output and employment levels low. Thus,
a decline in prices and wages will result in further unemployment.

In the classical model, output and employment levels are determined by the supply factors
only. However, according to Keynes, effective demand in the economy is an important
determinant of employment. The background of the Keynesian Theory is the period of Great
Depression of 1930s. In his book “General Theory of Employment, Interest and Money”
published in 1936, Keynes gives four propositions for market adjustment and employment.
These are:
1) The economy may be in equilibrium at any level of employment and that full employment can
only be a temporary phenomenon and quite unstable which may even drive the economy into
a situation like depression.
2) Lack of aggregate demand is a cause of unemployment in the economy.
3) An immediate reaction to a decline in aggregate demand would be a decrease in output and
employment. This would then bring wage and price adjustment.
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4) Government spending is important in helping raise the aggregate demand. Thus, government
can and should adopt measures to manage aggregate demand thereby improving the level of
employment.

Check your progress – 1

Note: a) Write your answer in about 50 words.

b) Check your answer with possible answers given at the end of the unit

1. What according to Keynes are the major limitations of the classical theory?
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2. How does flexibility in wages and prices help in the determination of output and employment
in the classical model?
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To understand the process, we begin with the concept of equilibrium output level, which
refers to a sustainable level of output; a level where total income (as a result of production) is
matched by total spending enough to clear the output. That is, the aggregate demand matches
with aggregate supply. But before that

9.04 Aggregate demand

Aggregate demand plays a significant role in the determination of employment. Aggregate
demand is the amount of goods and services demanded at a given price. In other words, it
shows the levels of consumption at the given output –income levels. It is the proceeds that the
producers actually expect to get at a given level of employment. With changes in the level of
employment, income would also change and therefore the demand for goods will also change.
According to Keynes, there are four components of aggregate demand. These are: the
consumption demand, investment demand, demand by the government sector and net exports

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(i.e., exports minus imports). Both government expenditure and net exports are exogenous
factors.

Government expenditure is autonomous and depends on policies rather than income. During
recession, when the business expectations are low, government can resort to public spending
and taxes. These policy instruments help to bring stability in the economy. As for the
consumption demand, it is determined by the propensity to consume and the disposable
income. As for the disposable income, it is the income available to the households after
paying taxes. A part of this income is saved and rest is used for consumption purposes. Thus,
income will be equal to consumption plus the savings.

According to Keynes, as income increases, consumption also increases but not in the same
proportion as income. This is because, as income increases, more and more wants of the
individual are satisfied and therefore the expenditure on consumption decreases
proportionately with rise in income and savings increase. Keynes calls it the marginal
propensity to consume. In short, as income increases, Marginal propensity to consume (MPC)
decreases whereas the propensity to save (MPS) increases. The relationship between income
and consumption is explained with the help of the consumption function. It is based on the
following assumptions:
a) Propensity to consume of the people does not change.
b) There are no abnormal conditions such as war or inflation, etc.
c) There is no government interference.

There are two useful concepts in the relationship between income and consumption. During
any given period of time, the ratio of consumption to income is average propensity to
consume (APC). Symbolically,
APC=C/Y
where C is consumption and Y is income.

Marginal propensity to consume (MPC) is the incremental consumption as a result of

incremental change in income.

or

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 Where ΔC is the change in consumption
and Δy is the change in income.
In the short run, consumption function will be

Where a is the intercept and is the autonomous consumption

B is the slope of the function.
The consumption demand can be shown with the help of the following diagram

Figure 9.1
Y
Z
Consumption Expenditure

consumption function
C=a+by

0
X
National Income

In the above diagram, OZ is the income line and the curve CC represents the consumption
function of the community and slopes upward showing that as income of the community
increases, consumption also increases. In the Keynesian analysis, as income increases, a part
of it is saved. Symbolically,
Y=C+S
Where
Y is income
C is the consumption and
S is savings

After a point with increase in income, savings grow. In the short run, the consumption
function does not change as has been said earlier.

Another component of the aggregate demand is the investment demand. According to Keynes,
net addition to the stock of capital is investment. Investment demand is important in the

159
determination of income and employment. It depends on the rate of interest and the marginal
efficiency of capital or the rate of return on capital. In the short run, the rate of interest does
not fluctuate much and is relatively stable. Hence, in the short run, it is the rate of return that
is important in determining investment demand.

Keynes suggests that any initial investment in the economy has an impact on income known
as the multiplier effect. It shows the relationship between investment, income and
employment. Initially, the concept of multiplier was used by R.F. Kahn as employment
multiplier. It represents a change in output due to a unit change in aggregate demand. Keynes
adopted the concept for investment multiplier. It shows the relationship between aggregate
investment, income and employment due to a unit change in consumption demand.
Symbolically, multiplier, represented as
K is

or

And
ΔY= K. ΔI

Where MPC is the marginal propensity to consume

MPS is marginal propensity to save
I &Y are investment & income respectively.

A change in aggregate demand may be caused due to a change in consumption expenditure or

an investment or both. At the full employment level or equilibrium level, income is given and
therefore consumption is also given.

Figure 9.2

E1 C+I+ΔI
E
C+I
Consumption and Investment

ΔI
C
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 ΔY

0 Y Y1 Income

Investment is an exogenous factor and it may change due to changes in interest rates,
expansion of market, etc. Suppose autonomous investment takes place and investment
increases in the economy. This will result in increase in production, thereby resulting in to rise
in the income of the factors of production in the form of wages, interest and profit. This rise in
the income of the factors of production will be K times the increase in investment. This will
further result in rise in the aggregate demand owing to increase in consumption. This process
will continue so long as the increase in income and expenditure continues. This is shown in
the following diagram:

In the above diagram, C is the initial investment. At some point of time for some reason,
suppose the investment increases by ΔI, then this will result in an increase in income from Y
to Y1. Suppose the value of MPC is 0.5 then the rise in income would be 2 times. The value of
ΔY is twice the ΔI.

The process can be understood with the help of a simple example. Suppose there is an
autonomous investment of Rs. 100. This means that an additional income of Rs.100 has been
generated. A part of this income would be used for consumption purpose. Assuming the

marginal propensity to consume as 0.6, ` 60 would be used for consumption of goods and

services. This expenditure on consumption creates an income of ` 60 in the following period.

This will result in an additional income of ` 36 in the later stage. This process of generation of

income will continue so long as the income generation tends to be zero. So long as this
process of multiplier continues, income and employment generation in the economy
continues.

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9.05 Aggregate Supply

Aggregate supply is the value of goods and services produced during a period of time in the
economy. It shows various possible levels of output at which the market must expect to
receive income equivalent to its cost of production. It constitutes the producers’ goods and the
consumer goods. In other terms, it can also be said that it is the value of goods and services
distributed among various factors of production.

Aggregate supply during any period depends on the availability of capital, technology and the
labour. Since the Keynesian analysis is a short run analysis, it is assumed that the stock of
capital and technological changes do not take place. Hence, labour is the only factor of
production that varies with the level of output. As output increases, employment will also
increase. Therefore, with rise in production, more labour would be employed. This would be
possible only when the producers expect to receive higher revenue. It is also assumed that
since the capital and technology remain constant in the short run, the productivity of the
workers also does not change. Hence, productivity, prices of the products and wages being
constant in the short run, the aggregate supply curve is an upward sloping curve as shown
below.
Figure 9.3
AS
AD
Aggregate Supply

P E

Income
As is shown in the diagram, at a given price, varying levels of goods would be supplied
depending on the aggregate demand. Higher the aggregate demand, higher would be the
aggregate supply. At point E aggregate supply is equal to aggregate demand curve. It is the
equilibrium level of income in the economy. Income of the economy cannot increase beyond
162
this point because any increase in aggregate supply will not be matched by rise in aggregate
demand. Hence, deficiency in aggregate supply will result in a fall in the income level. This
point of equilibrium level at which aggregate supply equals aggregate demand is the point of
effective demand. Keynes viewed that the economy may not be in equilibrium at the level of
full employment as in the classical theory. According to him, the economy can be in
equilibrium even with certain unemployment. This is because savings and investment may not
be equal as the class of investors and the people who save are different. People save money
for precautionary motives also. Therefore, level of investment may be lower than the savings
resulting into savings gap. The government expenditure in the Keynesian theory is
autonomous and is not determined on the basis of income level.

Whenever there is a recessionary situation in the economy, a wide spread cyclical

unemployment exists. This is attributed to pessimistic conditions about returns on investment
in the market. This will result in the decline in the unemployment level. It is shown in the
following diagram.
AS
Figure 9.4
AD
E
AD=C+I
E1 AD1

I0 I
ΔI
ΔN
0 N0 N
Investment Employment

The Initial investment level is shown by the curve I at the given interest rate R and the
economy is in equilibrium at point E with ON level of employment. Due to recession in the
economy, investment declines from I to I0 despite no change in the interest rate. Because of
this decline in investment the employment level declines from 0N to 0N0. ΔN is the level of
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 cyclical involuntary unemployment. This decline in employment is due to decline in
investment and further results in decline in income.

The rate of interest is generally stable and does not change in the short run. It is the marginal
efficiency of capital that will determine the level of investment in the economy. Marginal
efficiency of capital in turn depends on the cost of replacement of capital goods and expected
rate of return. The expected rate of return will vary with change in output level even in the
short run. Keynes assumes that investment is autonomous and does not vary with the change
in the level of income. In fact, with change in the level of income the demand for consumer
goods will also change. Any increase in the demand for consumer goods will raise producers’
expectations about the rate of return resulting in the rise in the level of investment.
During depression in a capitalist economy, the problem is to utilise the unemployed labour
and capital for increasing production by raising the aggregate demand. Thus, aggregate supply
curve will remain unchanged and full employment will be achieved by increasing aggregate
demand that means an upward shift in the aggregate demand curve. This is shown in the
following diagram
Figure 9.5
AS

A E
Wages and Prices

AD2 AD1

0 Q1 Q0
Production and employment

In a situation when there is a fall in the aggregate demand from point E to A, aggregate
demand curve shifts from AD1 to AD2. The fall in demand will result in a fall in output
164
without bringing any change in prices and wages. In such a situation, the solution lies in an
increase in aggregate demand. In response, production will boost up. This will be possible
because of massive unused resources and high levels of unemployment. At the given price
level, demand will increase without causing any general price level to rise. Once the economy
reaches the situation of full employment, any increase in aggregate demand will result in an
inflationary situation as output and employment cannot increase further. It would be possible
with the change in technology and increase in capital. This would mean a shift in the
aggregate supply curve towards right. In short, Keynes assumed that both wages and prices
are sticky at high levels of unemployment.

According to Keynes, the cause of involuntary unemployment in the economy is rigidity in

wage rates. In the short run, wages do not adjust with the given demand and supply
conditions. The reasons for this are:
1. Trade unions play an important role in the determination of wages in a capitalist
economy. Since the wages of the workers are fixed through collective bargaining, a
downward shift in the wages is not accepta.ble to them even in case of rising
unemployment levels.
2. The government intervenes in the determination of the minimum wages of the workers
and hence, a downward change may not be allowed even in case of demand and
supply imbalance.
3. At the times, the employers themselves are not interested in lowering wages as this
may affect the efficiency of the workers. Higher the wages, higher would be the
efficiency of the workers. Thus, despite an increase in the supply of labour, wages
would not decline.
4. If there is a decline in the wage rate, workers themselves may resist. According to
Keynes “while workers will usually resist a reduction of money wages, it is not their
practice to withdraw their labour whenever there is a rise in the prices of wage
goods.” Thus, a cut in money wages may not be acceptable to workers but decline in
real wages, which is due to rise in prices; will not be resisted by the workers.

9.06 Cyclical Unemployment and Keynes

Achieving high levels of employment and income are important objectives of the policies of a
country. Keynes emphasised the significance of fiscal policy for eradicating unemployment.
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Fiscal policy, monetary policy or a combination of both would be an effective instrument for
achieving high levels of employment with stability. During the recession, an increase in
government expenditure on public works programme will help bring a rise in aggregate
demand and generate employment and income. This in turn, will help in bringing the
economy out of recession. Alternatively, government can also resort to cut in the tax rates. A
cut in the personal tax rate (for instance, income tax) will result in an increase in the
disposable income thereby increasing the demand for consumption. This will boost aggregate
demand and help clear unemployment thereby bringing the economy out of a recessionary
situation.

Keynes and the Keynesians were of the view that monetary policy cannot be an effective
instrument for raising employment levels. During recession, business class is pessimistic
about returns on investment and any increase in money supply through liberal monetary
policy would not be effective in bringing the economy out of recessionary situation and
massive unemployment. In short, Keynes was a strong supporter of a fiscal stimulus or pump-
priming and deficit financing in times of recession in order to raise the levels of effective
demand and employment.

Keynes advocated two important fiscal policy prescriptions. Firstly, the government need not
focus on balancing the budget. Even if the public expenditure is high compared to the
revenue, there is no cause of concern. Secondly, for funding of the public works programme
government can resort to borrowing.

During recession, as public spending increases, there is an increase in income. If there is a cut
in the tax rate, disposable income increases. Both rise in public expenditure and a tax-rate cut
will have a similar impact on income. These policy measures will result in an increase in
income, thereby increasing consumption demand depending on marginal propensity to
consume of the people thereby giving a boost to the economy.

Public expenditure has an important impact on raising aggregate demand during recession.
The expenditure incurred by the government will have a multiplier effect and give a boost to
the economy by raising income and consumption (depending on the marginal propensity to
consume of the people) thus, leading to a rise in the employment levels. During depression a
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policy of deficit financing might help the government in maintaining a steady level of
employment and income (Hajela, 2009).

Hajela (2009) classifies the public expenditure in two categories- pump priming and
compensatory spending. “Pump-priming refers to the expenditure initially made by the
government to give a boost to the economy which has reached a stage of stagnation. It does
not replace private investment, but merely injects fresh purchasing power to stimulate private
investment”(Hajela, 2009). Compensatory spending on the other hand implies the making of
the deficiency in private investment. It shall have to continue until the private investment does
not regain its normal level (Hajela, 2009). Compensatory expenditure includes infrastructure
building. It can also take the form of social security benefits. While the former will help in
boosting employment level and effective demand; later will have a direct impact on
consumption levels thereby resulting in rise in the demand, output and employment.

9.07 Post Keynesian Approach

Keynes emphasised the importance of the fiscal policy to improve the employment levels.
However, post-Keynesian approach was a move away from fiscal policy and emphasised the
role of monetary policy as a prescription. According to this approach, fiscal policy cannot be
an effective instrument in stabilizing the economy. Supply of money is an important factor
that has an impact on income and plays a significant role in the determination of production
and employment in the short run. The state of the budget by itself has no significant effect on
the course of nominal income, on deflation or on cyclical fluctuations (Milton & Heller,
1969).

Another proposition put forward by the monetarists is that the private sector is stable whereas
instability in the economy is primarily the result of government policies (Froyen, 2014).

According to the proponents of monetarism (Milton Friedman & others) fiscal policy cannot
be an effective instrument in stabilizing the economy and that money supply is an effective
instrument. The central bank of the country determines the money supply. Any change in the
money supply by the central bank will determine the income level. The monetarists also assert
that in the long run, real output is determined by the factors such as stock of capital goods,
size and quality of labour force and technology (Froyen, 2014). In the short run, it is the
167
 money supply that will help determine the output and employment. Prices including wage
rates are not perfectly flexible. Thus, when the quantity of money changes in the short run,
prices do not make full adjustment. Output and employment are affected (Froyen, 2014).

Check Your Progress – 2

Note: a) Write your answer in about 50 words.
b) Check your answer with possible answers given at the end of the unit

3. Explain the process of multiplier. ------------------------------------------------------------------------

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4. What are the components of aggregate demand?
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5. What are the propositions for market adjustment and employment in the Keynesian model?
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9.09 Let Us Sum Up

Classical economists emphasised a self-regulating mechanism in the economy. They
emphasised that even in a laissez faire economy with no government intervention the
economy can achieve full employment through automatic adjustment in the market factors.
Keynes on the other hand adopted a demand-side approach and according to him, low
investment level and aggregate demand are the reasons for unemployment in any economy.
One important aspect of the model is that demand plays an important role in the determination
of income and employment. The process of multiplier induces consumption expenditure via
investment and can help bring changes in the income.

9.10 Key Words

168
Accelerator The accelerator shows the relationship between investment and change in
income.

Aggregate demand is the amount of goods and services demanded at a given price. In other
words, it shows the levels of consumption at the given output –income levels.

Aggregate supply is the total amount of goods and services (real output) produced and
supplied in an economy over a period of time. It includes consumer goods, capital goods, all
public goods and merit goods.

9.11 References and Select Readings

Beltante Don & Jackson Mark(1979), Labour Economics: Choice in Labour Markets, Mcgraw
Hill Co., New York, 2nd Edition.
Bloom Gordon F. and Northrup Herbert R.(1950), Economics of Labour and Industrial
Relations, The Blakisten Co., Philadelphia, Toronto.
Carlin Wendy & Soskice David, (2007), Macro Economics: Imperfections, Institutions &
policies, Oxford University Press, Indian Edition, New Delhi
D’Souza Errol, D.(2008), Macro Economics, Pearson Education, new Delhi.
Dillard Dudley(1948), the Economics of John Maynard Keynes, Englewoods Cliffs, New
Jersey, Prentice Hall, Inc.
DornBusch Rudiger, Fischer Stanley and Startz Richard(2004), Macro Economics, Tata
Mcgraw Hill, New Delhi.
Friedman Milton and Heller Walter(1969), Monetary versus Fiscal Policy, Norton, New York.
Froyen, Richard T.,(2014), Macro Economics: Theories and Policies, Pearson Education,
Dorling Kindersley(India) Pvt. Ltd., New Delhi.
Greenaway David, Bleaney Michael & Stewart Ian(eds.), A guide to Modern Economics,
Routledge, London, Chapter 3
Gupta G.S.(2008), Macro Economics: Theory and Applications, Tata Mcgraw Hill, New
Delhi.
Hajela T.N. (2009), Macro Economic Theory, Ane Books Private Ltd., New Delhi.
Hamer mesh Daniels & Rees Albert (1984), The Economics of Work and Pay, 3rd Edition,
Harper & Row Publications, New York.
Keynes, J.M., (1948), The General Theory of Employment, Interest and Money, MacMillan,
London.
Phelps Orme W.(1961), Introduction to Labour Economics, McGraw Hill Co., New York

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9.12 Check your progress possible Answers

Ans 1. According to Keynes, unemployment is not caused by faulty operation of the labour
market but rather is the result of insufficient effective demand and can only be resolved
by creating more jobs—which in turn requires higher demand for the output that would
be generated by the additional workers.

Ans 2. Classical economists suggested that wages should be flexible along with the prices of
raw material, capital and products. If prices are flexible enough to adjust easily with
changes in demand, then resources will be utilised and unemployment will be at the
minimum. Thus, high levels of output and employment will be maintained.

Ans 3. Multiplier shows the relationship between a change in income and employment due to
a unit change in consumption demand. A change in aggregate demand may be caused
due to a change in consumption expenditure or an investment or both. At the full
employment level or equilibrium level, income is given and therefore consumption is
also given. Investment is an exogenous factor and it may change due to changes in
interest rates, expansion of market, etc. Suppose autonomous investment takes place
and investment increases in the economy. This will result in increase in production,
thereby resulting in to rise in the income of the factors of production in the form of
wages, interest and profit. This will further result in rise in the aggregate demand owing
to increase in consumption. This process will continue so long as the increase in
income and expenditure continues. This process of generation of income will continue
so long as the income generation tends to be zero. So long as this process of multiplier
continues, income and employment generation in the economy continues.

Ans 4. There are four components of aggregate demand. These are: the consumption demand,
investment demand, demand by the government sector and net exports (i.e., exports
minus imports).

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Ans 5. According to Keynes, as income increases, consumption also increases but not in the
same proportion as income. This is because, as income increases, more and more wants
of the individual are satisfied and therefore the expenditure on consumption decreases
proportionately with rise in income and savings increase. Keynes calls it the marginal
propensity to consume. In short, as income increases, Marginal propensity to consume
(MPC) decreases whereas the propensity to save (MPS) increases. Increase in MPS will
boost investment in the economy thereby resulting into rise in output and employment.

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