Keynesianism – 2

I am back with Keynesianism again. Before continuing, I would like clear the doubts raised by MOHIT GARG. He asked...

Hi Sir

Can u elaborate what is marginal disutility in 1st assumption & involuntary unemployment in 2nd assumption.

In the 1st assumption, according Keynes, the classical theory says, wage of an employed person is equal to the value which would be lost if employment were to be reduced by number of unit, that is marginal disutility. That is value or units of value lost due to non use of employment. And Keynes contradicts this. He says 1st & 2nd assumptions themselves are contradicting each other!!!

And in 2nd assumption, Keynes said there is no involuntary unemployment. First let me explain to what is involuntary unemployment. Workers will be ready to work for whatever the wage they get but, they will not get employment due to various reasons like reduction will in the aggregate demand, the market structure & government intervention. Keynes says, in these kinds of cases, there is no question of INVOLUNTARY; everything will be VOLUNTARY only since it will lead to increase in supply of labour & aggregate demand for it.

Now coming to today’s post, today I read 3rd chapter, in which he talks about the aggregate demand. He says the number of employment depends on the aggregate demand & supply price compared to his total cost.

In this chapter he contradicts the Classical theory which says “Supply creates its own demand”. And he proves that using aggregate supply & demand equations. He says that classical theory works when aggregate demand is equal to aggregate supply which is in equilibrium. And equilibrium can’t be realistic in the world where we live. If Say’s law hold good then there would have been robust demand due to continuous supply, which would have resulted a full employment, which is in myth!

In this chapter he says that,

1. Resources, costs & income depends on the volume of employment

2. Consumption will depend on the level of aggregate income and, therefore, on the level of employment N, except when there is some change in the propensity to consume

3. Amount of labour depends upon amount which the community is expected to spend on consumption & the amount which it is expected to devote to new investment.

4. Hence the volume of employment in equilibrium depends on (i) the aggregate supply function, (ii) the propensity to consume, and (iii) the volume of investment.

Paradox of poverty in the midst of plenty:

This is important statement made by the Keynes which exactly suitable present crisis. Keynes says that, the propensity to consume & rate of new investment decides the employment. If these two decreases, then there is decrease in employment ready to work at the existing wage, and the equilibrium wage will be greater than the marginal disutility of the equilibrium level of employment. See here again contradicts the 1st assumption (that the real wage is equal to the marginal disutility of the existing employment) on which classical theory depends…

Bottom Line (Not mine, its Keynes statement):

It may well be that the classical theory represents the way in which we should like our economy to behave. But to assume that it actually does so is to assume our difficulties away.