Keynes used 'aggregate demand and aggregate supply approach' to explain his simple theory of income determination. The rate of interest is determined by the demand for money and the supply of money. Employment thus depends on investment and it varies in the same direction as the volume of investment. Keynes brings out all the important aspects of income and employment determination and Keynesian economics itself can be called macro economics. Aggregate demand is the total amount of goods demanded in an economy. Keynes laid more emphasis on the determinants of aggregate demand and to a greater extent ignored the determinants of aggregate supply. If unemployment is to be averted, the remedy lies in increasing the effective demand.
In keynes theory investment being determined by marginal efficiency of capital and rate of interest does not depend on the level of income. Our tutors are highly qualified and hold advanced degrees. The value of the output is just the same to the national income at full employment level. Public hold money M in cash for three motives: transactions, precautionary and speculative. Online Keynesian Model of Income Determination in A Two Sector Economy Help: If you are stuck with an Keynesian Model of Income Determination in A Two Sector Economy Homework problem and need help, we have excellent tutors who can provide you with Homework Help. In fact, national product and income are the same things. However, the amount of labour employed out of this given size of population can vary depending upon the demand for labour.
The exception is aggregate expenditures on consumption. Keynes argues that prices will not fall further below P 2 because workers and other resources will resist any reduction in their wages, and this resistance will prevent suppliers from increasing their supplies. According to Keynes, employment can be hiked by enhancing consumption and or investment. It is worth mentioning that in the short-run consumption function does not change. Therefore the interest held under these two motives M1 is a function L1 of the level of income Y , i. Since Keynes assumes all these four quantities, viz. As effective demand increases employment also increases.
They believe that prices and wages are sticky, especially downward. That is why modern economists also call macro economics as the theory of income determination. As a result, the multiplier also reduces. The other determinant of investment is the rate of interest. Investment is assumed to be autonomous and thus independent of the income level.
The marginal efficiency of capital means the expected rate of profit which the business community hopes to get from the investment in capital Fig. Aggregate demand involves concepts namely aggregate demand for consumer goods and aggregate demand for capital goods. The equilibrium position between aggregate demand and aggregate supply can be below or above the level of full employment as is shown in the curve below. The equilibrium level of income or output depends on the relationship between the aggregate demand curve and aggregate supply curve. If due to the adverse changes in the profit expectations of the entrepreneurs, level of investment falls, the equilibrium level of national income will also decline.
The book revolutionized macro economic thought. In the Keynesian thesis, employment is based on effective demand. S is the saving curve. Thus when at a given level of national income, aggregate expenditure i. Therefore, in our Figure 5.
According to Keynes, the equilibrium level of employment will be one of under-employment equilibrium because when income increases consumption also increases but by less than the increase in income. There are several other points on the aggregate demand expenditure curve but what distinguishes effective demand from all these points is that at this point aggregate demand is equal to aggregate output. For example, in the two-sector economy, the government is not involved in activities, such as taxation, expenditure, and consumption. Since unemployment results from the deficiency of aggregate demand, employment and income can be increased by increasing aggregate demand. Thus the amount held under these two motives M1 is a function L1 of the level of earnings Y , i. Since Keynes believes the aggregate supply function to be stable, he contemplates his entire concentration upon the aggregate demand function to fight gloominess and redundancy. Does not have government interference.
Investment Demand: The other component of the aggregate demand is investment which is a crucial factor in the determination of equilibrium level of national income. If government is there, it does not have any role to play in the economic activity of a country. Determination of National Income in Two-Sector Economy : The determination of level of national income in the two-sector economy is based on an assumption that two-sector economy is an economy where there is no intervention of the government and foreign trade. There will be equilibrium in the goods market when total output of goods and services produced will be equal to the total demand for output. If required investment is not made to fill this gap, it will lead to deficiency of effective demand resulting in unemployment. Keynesians, however, believe that prices and wages are not so flexible. In short-run, the equilibrium point remains constant that is the level of national income remains constant.