Further, Keynes neglected the relationship between capital stock and investment. This is the basic difference between Classical Theory and Keynesian Theory. Classical Vs Keynesian Economics 1235 Words | 5 Pages. It also depends on the extra unit of output that an additional worker can produce if added to the current workforce. Hence equilibrium level of income occurs at level of full employment, i.e., there is always full employment equilibrium. The man whose work stirred people’s minds so as to elicit such passionate appraisals was ipso facto no mediocrity.” Rather, he was a genius. His method of comparing different equilibrium levels of income has been termed comparative statics. This makes his theory inapplicable to socialist or communist societies where the entire economy is regulated by the state. Explain the meaning of aggregate supply (AS). The Classical Theory of Income and Employment is premised on three conjectures. Keynes, on the other hand, integrated monetary theory and value theory. Though he said that the role of public investment was to supplement private investment and not to supplant it, yet public investment has tended to replace private investment to a large extent. Calculate consumption level for Y = र 1000 crores if consumption function is C = 300 + 0.5Y. Mind, level of household consumption depends directly on the level of income. As a result, employment and income will also rise. In fact, the application of Keynesian policy measures to such economies has created more problems instead of solving them. Determination of Equilibrium Level 7. Besides, every bit of Keynesian analysis has been criticised, such as aggregate demand, aggregate supply, the consumption function, the investment function, the monetary theory, etc. 2. Disclaimer 9. On the other hand, Keynes considered the existence of full employment in the economy as a special case. Keynesian Theory of Income Determination . Keynes also did the same thing. 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.”. Both the Keynesian multiplier and Friedmanian real velocity are non-starters. Classical theory of unemployment affirms unemployment depends on the level of real wages. 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. 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. The demand for money arises from the transactions motive, the precautionary motive and the speculative motive. Keynesian economics also recognizes that only a fraction of the household income will be … The classical theory of employment states that in a labor market, employment for labors is determined by the interaction between demand and supply of labor, where the workers provide a constant supply of labor, while the employer makes demand for them. 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. There is no possibility of under-employment equilibrium in the long-run. “Keynes’s greatest achievement,” according to Prof. Sweezy “was the liberation of Anglo-American economics from this tyrannical dogma.”. For this, they have to determine the level of output to be produced and the number of workers to be employed. Perfect competition exists in the economy for both product market and factor resource market. In this field, as opined by Mrs. Robinson, “Keynesian revolution commands the field.”. Say's Law of Market. Emphasis on the Study of Allocation of Resources Only 3. 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 The Keynesian Theory is different from Classical theory in the following ways: Unemployment: Keynesian Theory accepts the fact that there is unemployment, the economy cannot function always on Full Employment Mode, it is just possible for a short period. “The unit of analysis must be the individual commodity or commodities grouped in some other manner, e.g. given level of income. Say's Law of Market. Policy Implications 10. The theory is meant for short period equilibrium of full employment. As Prof. Hazlitt opines, “Inflation is at once an uncertain remedy for unemployment and unnecessary remedy for unemployment. The classical economics was a microeconomic analysis which the orthodox economists tried to apply to the economy as a whole. ADVERTISEMENTS: In this article we will discuss about:- 1. Classical economics places little emphasis on the use of fiscal policy to manage aggregate demand. the interest rate will not always equalize savings and investment. There is difference between these two concepts. Sufficient market exists for all the produced goods and services. The Keynesian theory is not applicable even to modern capitalist economies where there is monopolistic competition rather than perfect competition. No person is original in any pursuit of knowledge. But still the efficacy of classical theory in guiding public policy could not be successfully The classical and the neoclassical economists almost neglected the problem of unemployment. The New Keynesian theory arrived in … This led him to develop a systematic theory of employment, explaining the phenomenon of unemployment and suggesting the remedial measures. For instance, an unfavourable balance of trade leads to the flow of income abroad which results in the reduction of domestic income, investment and the volume of employment via the reverse operation of the multiplier. 2020 Zigya Technology Labs Pvt. There are jobless resources and therefore less than full employment symmetry prevails. On the one hand, Keynes regarded saving and investment as “merely different aspects of the same thing” and thus “necessarily equal.” On the other, they were regarded as “two essentially different activities without even a nexus” so that they tended to equality only in equilibrium. This made his theory of business cycles one-sided because his explanation centres round the principle of multiplier. The influence of the rate of interest in determining the volume of investment is very uncertain. Though the problems of today are somewhat different from what they were when Keynes wrote his General Theory, yet most economists approach the present day problems within the framework of the Keynesian analysis. The core issue of macroeconomics is the determination of level of income, employment and output. The theory is based on the assumption of long-run full employment equilibrium. 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. ADVERTISEMENTS: The Keynesian Theory of Income, Output and Employment! Two important theories of income and employments are : 1. Moreover, in America deficit spending by the government led to inflation instead of raising the volume of employment. Privacy Policy 8. Competition among labour to seek employment would lead to fall in wage rate. For a real understanding of the working of macroeconomic variables like income, investment, consumption, employment, etc., the study of their micro-behaviour is essential. He opines that “over-all demand is of course, to some extent, affected by relations on the supply side, Keynes’s treatment of demand was therefore over-simple in that it neglected the possibility that the relative prices prevailing in the different sectors determine, in part, the total amount of outlays.”, Professor Don Patinkin regards Keynes’ treatment of the aggregate supply function inadequate. Patinkin has shown that under-employment equilibrium “can exist even in a system of perfect competition and wage and price flexibility.” Hazlitt holds that “the market mechanism applies to the labour market. Download the PDF Question Papers Free for off line practice and view the Solutions online. 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. They are the wealth effect, technological change, education, expectations, attitudes toward assets, etc. Plagiarism Prevention 4. J. M. Keynesian theory is a general theory. (b) Keynes’s favoured public investment to overcome depression and to attain full employment. Introduction to Keynesian Theory: Keynes was the first to develop […] (f) Lastly, the Keynesian economics fails to provide solutions to a number of socio-economic problems facing the developed countries. Although there are many different views, these are often classified as the Classical, Neo-Classical, and Keynesianperspectives. KEYNESIAN THEORY OF EMPLOYMENT J.M. By integrating the value theory and monetary theory through the theory of output, Keynes made money non-neutral as opposed to the classical view of neutrality of money. 1. This makes Keynes’s analysis unrealistic. Variation in rate of interest establishes equilibrium between saving and investment. 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. In short, consumption equation, Consumption (C) at a given level of income (Y) is equal to autonomous. Keynesian model has been developed as a reaction against the classical model. Thus in the words of Joan Robinson, “The Keynesian revolution has destroyed the old soporific doctrines and we are left in the uncomfortable situation of having to think for ourselves.”. This is the basic difference between Classical Theory and Keynesian Theory. Keynes propounded the opposite view that demand creates its own supply. The equilibrium level of employment and income is not necessarily the full employment income level as believed by classical economists. Keynes himself remarked, “In the long-run, we are all dead.” He, therefore, assumed a given stock of capital equipment, existing technique, tastes and habits of the people, organisation, size of population, etc. Fall in aggregate demand was so severe that investment came down to its minimum level resulting in vast unemployment. • Classical economic theory is the belief that a self regulating economy is the most efficient and effective because as needs arise people will adjust to serving each other’s requirements. Keynes used his income‐expenditure model to argue that the economy's equilibrium level of output or real … Keynesian Theory of Income and Employment! Pigou, one of the foremost classical economists, favoured the policy of wage-cut to solve the problem of unemployment. Why? Keynes held that the level of saving depended upon the level of income and not on the rate of interest. Classical theory is the basis for Monetarism, which only concentrates on managing the money supply, through monetary policy. 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. The following points mark Keynesian theory as revolutionary and a genuine departure from the classical economics: The classicists believed in the existence of full employment in the economy and a situation of less than full employment was regarded, as abnormal. Before publishing your articles on this site, please read the following pages: 1. Saulnier points out that Keynes Notes on the Trade Cycle lack in factual proof. 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. Variables 5. As rightly observed by Harris, “Out of the straws of his predecessors, with some additions of his own, he had built a structure which no economist or economic practitioner can afford not to inspect or use.” No doubt the Keynesian economics is built on the classical economics but it differs significantly from the latter in terms of assumptions, presentation of tools of analysis and policy measures. Classical economics is the theory that free markets will restore full employment without government intervention. According to Hazlitt, the volume of employment is not a function of effective demand rather it depends upon the inter-relationship between wage- rates, prices and the supply of money. The classical economics was based on the laissez-faire policy of a self-adjusting economic system with no government intervention. Classical economic theory is of the view that the economy is self-regulating. Summary 6. 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. 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). Introduction to Keynesian Theory: Keynes was the first to develop a systematic theory of employment in his book. Moreover, economics is an incomplete study without concentrating on the long-run effects of these forces on the economy. The policy implications of Keynesian economics have also been criticised. The classicists emphasized the importance of saving or thrift in capital formation for economic growth. So aggregate demand should be raised in order to raise level of employment. The scope of this chapter is limited to Keynesian Theory. 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. Thus the aggregative nature of Keynesian economics detracts from its utility as a realistic study of economic problems. 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. If aggregate demand increases, level of output will increase to meet the increased demand. It was for this purpose that Keynes made his analysis more complicated by introducing the interrelation between the rate of interest and the marginal efficiency of capital to determine the level of investment. As Prof. Harris remarked aptly, “If communism comes, Keynes will be as dead as Ricardo.”. The Keynesian theory of interest is an improvement over the classical theory in that the former considers interest as a monetary phenomenon as a link between the present and the future while the classical theory ignores this dynamic role of money as a store of value and wealth and conceives of interest as a non-monetary phenomenon. Thus Keynes’s neglect of the repercussions of foreign trade on the volume of employment is a serious defect in his theory. The classicists artificially separated the monetary theory from the value theory. 4. Variation in income brings about equilibrium between saving and investment. His policy measures have been adopted by almost all the capitalist economies of the world. Under-employment equilibrium is a normal situation while full employment equilibrium is an ideal and special situation. Therefore, total spending, output, investment and interest rates are expected to remain unchanged in the long run, according to classical theory. It is assumed that in short-run, prices of goods do not change and elasticity of supply is infinite. 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. Keynes, on the other hand, adopted the macro approach to economic problems. He relied on “convention” for forecasting changes in business expectations and failed “to confront ex-ante and ex-post reasoning,” as Professor Hart puts it. product, labour and money. It was J. M. Keynes who first analyzed the frequent problem of unemployment and fluctuating levels of real output or national income. It has a wider application on all such situations of unemployment, partial employment and near full employment. Features of Keynesian Theory of Employment 3. As a result demand for labour would continue to rise until unemployment is removed from the labour market. Determination of Equilibrium Level 7. The aggregate supply is regarded as stable during the short-run. In case of Temporary situation of unemployment, a cut in money wage increases employment. Thus the direct relationship between effective demand and the volume of employment is fallacious. Distinguish between Classical Theory and Keynesian Theory of income and employment. It means that the cyclical upward and downward movement of employment and output adjust by itself. 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. 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. … Such problems include fair employment, income distribution and resource allocation. Assumption of Neutral Money 6. Moreover, it fails to solve the problems of underdeveloped countries. Keynes’s consumption function though regarded as an epoch-making contribution to the tools of economic analysis yet it is not free from defects. 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