Q.Explain the Keynesian theory of employment.

Keynes argued that the volume of employment is determined by effective demand, the point where the Aggregate Demand Price equals the Aggregate Supply Price. Effective demand depends on aggregate expenditure (consumption plus investment). Since consumption rises less than income, the resulting gap must be filled by investment; if investment is insufficient, equilibrium is reached below full employment, causing involuntary unemployment, and the state must step in to raise effective demand.

Background

The classical economists believed, following Say's Law, that supply creates its own demand and that the economy automatically reaches full employment. Keynes, writing after the Great Depression of the 1930s, rejected this and showed that an economy can be in equilibrium even with large-scale unemployment. His explanation rests on the principle of effective demand.

Aggregate Supply Price and Aggregate Demand Price

• Aggregate Supply Price (ASP): The total amount of money that all producers must expect to receive from selling the output produced by a given number of workers, just enough to induce them to offer that employment. The ASP rises as employment rises.
• Aggregate Demand Price (ADP): The total amount of money that all entrepreneurs actually expect to receive from the sale of output produced by a given number of workers. It depends on the expected spending of the community.

Effective Demand

Effective demand is the level of aggregate demand that becomes equal to aggregate supply. As employment increases, ADP and ASP both change, and at one level of employment the two become equal — that point of equality is effective demand. The level of employment fixed at this point is the equilibrium level of employment, which need not be full employment.

Role of consumption and investment

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