Q.State whether the following statement is true or false : ‘‘As per Keynesian theory in an economy, full employment can never exist.’’

Concept: Keynesian equilibrium and the possibility of underemployment equilibrium

Keynes challenged the classical view that markets automatically reach full employment. His central insight was that aggregate demand determines the equilibrium level of output and employment, not the other way around.

In the Keynesian framework, an economy settles at the level of output where aggregate demand equals aggregate supply. This equilibrium need not coincide with full employment — if demand is insufficient, the economy can remain stuck at an underemployment equilibrium with involuntary unemployment. However, Keynes never claimed full employment is impossible; rather, it requires active intervention (fiscal or monetary policy) to boost demand when the economy is below potential. …

The confusion here stems from misreading what Keynes actually said about employment equilibrium. Classical economists before Keynes believed that free markets would always self-correct to full employment through flexible wages and prices—unemployment was seen as temporary or voluntary. Keynes challenged this automaticity, not the possibility of full employment itself.

Keynes introduced the concept of underemployment equilibrium: an economy can settle into a stable equilibrium where aggregate demand is insufficient to employ all available labor, and this equilibrium persists because there is no automatic mechanism forcing the economy back to full employment. Wages might be sticky downward, investment might be depressed due to pessimistic expectations, and the interest rate might fail to equilibrate saving and investment.

The key insight is that full employment is possible in Keynesian theory, but it requires the right level of aggregate demand. When aggregate demand (consumption + investment + government spending + net exports) equals aggregate supply at the full-employment level of output, the economy achieves full employment. The problem is that this happy coincidence is not guaranteed by market forces alone.

1. Keynesian equilibrium condition: The economy is in equilibrium when aggregate demand $AD = C + I + G + (X - M)$ equals aggregate supply (national income $Y$). This equilibrium can occur at any level of output, not necessarily at full employment output $Y_f$.

2. The possibility of persistent unemployment: If aggregate demand is deficient—say, because investment is low due to poor business confidence or consumption is weak—the equilibrium output $Y_e$ can be less than $Y_f$. The economy settles there with involuntary unemployment, and without intervention, it stays there.

3. The role of policy: Keynesian theory explicitly advocates for fiscal and monetary policy to achieve full employment. Government spending can boost aggregate demand, shifting equilibrium output toward $Y_f$. If full employment could never exist, there would be no point in recommending such policies. …