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    Determination of Income and Employment

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    Shrey Goel
    This document discusses classical and Keynesian economic propositions about income, employment, and output. Classical economists believed that economies always achieve full employment equilibrium and money plays an insignificant role. Keynes argued that involuntary unemployment is normal and underemployment equilibrium is routine rather than an exception. The document also outlines the Keynesian model where aggregate demand determines output in the short-run when prices and wages are fixed.

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    Determination of Income and Employment

    Uploaded by

    Shrey Goel
    20 views30 pages
    This document discusses classical and Keynesian economic propositions about income, employment, and output. Classical economists believed that economies always achieve full employment equilibrium and money plays an insignificant role. Keynes argued that involuntary unemployment is normal and underemployment equilibrium is routine rather than an exception. The document also outlines the Keynesian model where aggregate demand determines output in the short-run when prices and wages are fixed.

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    This document discusses classical and Keynesian economic propositions about income, employment, and output. Classical economists believed that economies always achieve full employment equilibrium and money plays an insignificant role. Keynes argued that involuntary unemployment is normal and underemployment equilibrium is routine rather than an exception. The document also outlines the Keynesian model where aggregate demand determines output in the short-run when prices and wages are fixed.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    20 views30 pages

    Determination of Income and Employment

    Uploaded by

    Shrey Goel
    This document discusses classical and Keynesian economic propositions about income, employment, and output. Classical economists believed that economies always achieve full employment equilibrium and money plays an insignificant role. Keynes argued that involuntary unemployment is normal and underemployment equilibrium is routine rather than an exception. The document also outlines the Keynesian model where aggregate demand determines output in the short-run when prices and wages are fixed.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 30

    Determination of Income and

    Employment
    Classical Propositions
    Prominent proponents
    David Ricardo, James Mill, A C Pigou, J B
    Say
    Propositions
    An economy is always in equilibrium
    It always enjoys full employment
    Money plays insignificant role
    Underlying Assumptions
    Closed economy
    Demand and supply interact freely; no
    government control/regulation
    Consumers choose to maximize
    satisfaction
    Producers produce to maximize profits
    Wages and prices are flexible
    Economy in equilibrium-
    Says Law
    J B Say
    Supply creates its own demand
    Explains self correcting mechanism in
    case of overproduction or
    underproduction
    Disequilibrium, if exists, is temporary


    Economy at full employment
    equilibrium
    In case there is unemployment, wage
    flexibility will drive the labour demand
    and supply close to each other so that no
    involuntary unemployment prevails

    If demand for labour exceeds its
    availability, wage flexibility will again
    restore labour market equilibrium
    Money is insignificant

    Money acts as a medium of exchange

    Money aids transactional efficiency
    Do you see anything wrong in
    the Classical propositions?
    Meaning: Output/Income
    Actual Output : The output and therefore
    the income which is generated in the
    economy at the prevailing level of
    employment

    Potential Output: The level of output
    which the economy would produce if all
    the factors were fully employed
    Output/Income
    In short run, actual
    output may deviate
    from potential output

    Short Run
    fluctuations define
    the business cycles
    that are experienced
    by economies all over
    the world

    In long run, actual
    output potential
    output

    Also, potential output
    grows over time as
    the economys stock
    of factor inputs grows
    TROUGH/RECESSION
    Low prices
    Low profits
    High unemployment
    Low wages, interest
    Pessimism prevails
    Economic suffering

    RECOVERY/EXPANSION
    Low prices induce materialization of consumer
    demand
    This induces demand for capital goods
    Sales recover in all sectors
    Employment improves
    Prices recover, wages scale up, interest rates
    increase.

    BOOM/PEAK
    Sales grow, production facilities are expanded,
    inventories grow
    Unemployment is low, employees feel more
    secure, factors experience near full employment,
    command high prices
    Healthy profits allow firms to pay good wages
    and employees are able to afford goods, revival
    of consumption
    Hectic activity everywhere/overheated economy





    DECLINE/CONTRACTION
    Economy has experienced the peak and now
    begins to slow down
    Extremely high prices discourage new ventures
    Eventually the expansion in demand, new hiring
    and new lending come to a halt
    Unintended piling of inventories, prices have to
    be lowered, profits turn into losses, layoffs and
    bankruptcies are prevalent
    What is the contrast in the
    objective of a firm and the
    objective of an economy?
    A firm aims at equilibrium
    output
    An economy wants full
    employment level of output
    Keynesian Proposition
    J M Keynes
    Involuntary Unemployment prevails in
    the economy
    Underemployment equilibrium output is
    routine rather than an exception
    Wage and price flexibility is questionable
    Unemployment - Variants
    Voluntary Unemployment
    Seasonal Unemployment
    Frictional Unemployment
    Structural Unemployment
    Disguised Unemployment
    Cyclical Unemployment
    Keynesian Model (Short Run)
    Assumptions: All prices and wages are
    fixed at given levels; involuntary unN
    t

    prevails
    Supply expands to meet demand if
    operating at < full N
    t
    level
    Actual output = Aggregate demand (in
    equilibrium)

    Aggregate Demand

    In a two sector economy:
    AD = C + I
    Consumption Function: C = f (Y)
    C = a + bY
    Show this graphically
    What are the savings in this case?

    Propensity to consume/save
    Average propensity to consume willingness to
    use a proportion of income for consumption

    Marginal propensity to consume proportion of
    additional consumption out of the additional
    income

    APC +APS = 1
    MPC +MPS = 1
    Factors influencing propensity to
    consume

    Base level of income
    Stability of income receipts
    Prices
    Future expectations
    Credit facilities
    AD
    Investment demand means the firms desired
    additions to their physical capital and
    inventories

    Investment demand depends upon the current
    guesses about future demand for their output

    Assume: I = I
    According to Keynes..
    Investment is independent of current
    national income levels
    Investment is dependent on
    Rate of interest to be paid on the
    borrowings made for spending on capital
    goods
    Marginal efficiency of capital
    Equilibrium
    Given the assumptions, the output market is in
    SR equil. when AD or planned aggregate
    spending equal the output that is actually
    produced
    AD = Y
    If AD < Y, there is unplanned addition to stocks
    If AD > Y, there is unplanned reduction in stocks

    Equilibrium - Graphically
    Examples
    Let C = 100 + 0.75Y and I = 200
    Find equilibrium level of NY

    Another example -
    Let C = 8 + 0.7Y
    I = 22
    Find equilibrium Y
    If I =-9, find the new equilibrium Y

    Multiplier
    A change in autonomous spending
    changes the national income/output by a
    multiple of the initial change; this
    multiple is known as the multiplier
    Defined as : the ratio of change in
    equilibrium output to change in
    autonomous spending
    Multiplier, k = 1 / (1 b)

    Paradox of Thrift
    When AD is low and the economy has
    spare resources, paradox of thrift shows
    that a reduction in the desire to save will
    increase the spending and increase the
    equilibrium income level.

    So, society will benefit from higher
    output and employment



    Show this Paradox graphically
    In this 2 sector model
    Discouraging HH saving is tough, so C is
    adversely affected and therefore Y
    Firms may not invest as demand may not
    be forthcoming, this also adversely affects
    Y
    The economy will settle at an
    underemployment equilibrium !

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