Q.Explain Keynes' criticism of Say's Law and his theory of effective demand and employment.

Keynes built his whole theory by directly rejecting one classical assumption that the Great Depression had made impossible to believe.

John Maynard Keynes (1883–1946) built his entire theory in direct opposition to the classical belief in Say's Law, and the resulting Keynesian framework remains the foundation of modern macroeconomics.

Say's Law and why Keynes rejected it: Classical economists, following J. B. Say, held that 'supply creates its own demand' — that the very act of producing goods pays out enough income (wages, rent, interest, profit) to the factors of production involved to purchase everything the economy produces, keeping the economy operating at, or quickly returning to, full employment. Keynes argued this reasoning was flawed in an important way: income earned from production need not all be spent — some of it is saved, and there is no automatic mechanism guaranteeing that everything saved by households is matched by an equal amount of investment spending by firms. If firms, for whatever reason (pessimism about future demand, for instance), invest less than households save, total spending in the economy falls short of total output, and firms respond by cutting production and laying off workers — precisely the mass unemployment Keynes had witnessed in the Great Depression of the 1930s, which classical theory could not adequately explain.

The theory of effective demand: Keynes argued that the actual level of national output and employment is determined by effective (aggregate) demand — the sum of planned consumption spending by households, planned investment spending by firms, and government spending — rather than being automatically fixed at the full-employment level. Crucially, Keynes showed that an economy can settle into an equilibrium at a level of output well below full employment, and remain there indefinitely, because nothing in the private economy forces effective demand back up on its own. A fall in investment (say, due to falling business confidence) reduces aggregate demand, which reduces output and employment, which reduces household incomes, which further reduces consumption spending — a downward spiral with no automatic floor at full employment. …