Keynesian theory of employment
J.M. Keynes was the first to develop a systematic theory of employment in his book “The General Theory of Employment, Interest and Money” published in 1936. The classical and the neo classical economists almost neglected the problem of unemployment. They regarded unemployment as a temporary phenomenon and assumed that there is always a tendency towards full employment. It was Keynes who led the vigorous and systematic attack on the classical theory of employment and replaced it with general and more realistic theory.
Keynes’ main criticisms against classical theory were on the following two grounds:
1.The classical prediction that full employment equilibrium will be achieved in the long-run was not acceptable to Keynes who wanted to solve the short-run problem of unemployment. According to him, “in the long-run, there is no problem because we all are dead in the long run.”
2.Keynes criticized the classical assumption of a self-regulating economy. The great depression of the 1930s led Keynes to believe that the economy was not self-regulating; that the full employment equilibrium would not be automatically achieved in the short-run; and the government intervention was necessary to tackle the problem of the economy.
Keynesian theory of employment is also called the “Effective Demand theory of Employment” or “Principle of effective Demand”. According to this theory, the cause of unemployment is a deficiency of effective demand, and the method to solve the unemployment problem is to raise effective demand.
Assumption
- Keynesian theory of employment is based on the following assumptions:
- Keynes confines his analysis to the short-period.
- He assumes that there is perfect competition in the market.
- He assumes a closed economy ignoring the effect of foreign trade.
- His analysis is a macroeconomic analysis, i.e., it deals only with aggregate facts.
- He assumes the operation of the law of diminishing returns or increasing cost.
- He assumes that labor has a money illusion. It means a worker feels better when his wage doubles even when prices also double.
