Monday, December 12, 2011


Say's Law: The classical economists try to explain the economic theories on the assumption of full-employment. Full-employment means a situation in the economy where the people are willing to work and able to work.

They admitted that there could be 4% to 5% unemployment in the economy. When all the labourers are more or less employed, other factors of production will also be employed. In other words, at the time of full-employment there will be no idle resources in the country.

The classical economists developed the concept of full-employment on the basis of Say's Law. According to Mr. J. B. Say "supply creates its own demand". Whatever amount of goods is produced in the country will automatically be demanded in the country. This is because due to the increase in production, employment will increase. This will increase the income of the suppliers of factors of production. Thus, with the increase in income, demand will also increase. Hence it will be profitable for the businessmen to employ more labourers. As a result of this, all the labourers will be fully employed or occupied.

Thus Say's Law plays an important role in classical economic theories.

Keynes' Theory: Mr. J. M. Keynes did not accept the concept of full-employment. So he tried to develop a new concept of employment. According to him, employment in the economy depends on many factors. Of these factors, the most important factor is the Marginal Efficiency of Capital.

According to Mr. Keynes, employment depends on expenditure. When the expenditure is more, the effective demand will be more. This will increase the price, profit, investment, production and employment. But expenditure depends on the income. When the income is more, expenditure will be more. But the income is the sum of 1) consumption, 2) investment and 3) government expenditure.

1) Consumption: In order to satisfy the economic wants, man uses goods and services. Thus consumption depends on two factors, income and propensity to consume. Propensity to consume shows the relationship between change in income and change in consumption. When people consume more with an increase in income, propensity to consume will be more. But propensity to consume is influenced by many other factors. Some of the factors are as follows:

a) Distribution of income in the society: According to Mr. Keynes, the psychology of the people is that when people have less income, propensity to consume will be more.

b) When the desire to imitate others is more, the propensity to consume will be more.

c) If the government levies more taxes on expenditure, propensity to consume will be less.

d) If the people are economical, propensity to consume will be less.

e) If the propensity to save is more, propensity to consume will be less.

The propensity to save is again influenced by other factors, such as

i) the opportunity to save
ii) the power to save
iii) social position
iv) social guarantee
v) rate of interest, etc.

2) Investment: Investment in the economy is primarily determined by two factors

a) Marginal Efficiency of Capital
b) Rate of Interest

a) Marginal Efficiency of Capital: It shows the relationship between change in marginal investment and expected return out of that investment. When the expectation of return is more, marginal efficiency of capital will be more and vice versa.

This marginal efficiency of capital again is determined by many other factors.

i) Population: If the rate of growth of population is quite fast, effective demand will be more in the economy. Hence marginal efficiency of capital will be more.

ii) Innovation: If businessmen succeed to introduce new techniques and new machines, cost of production will be low, and so marginal efficiency of capital will be more.

iii) Taxes: If the government levies more taxes on production, cost will increase, and so marginal efficiency of capital will be less.

iv) Stock of goods: If the existing stock of finished goods is more, marginal efficiency of capital will be less.

v) Existing rate of investment: If the rate is more, marginal efficiency of capital will be more.

b) Rate of Interest: According to Mr. Keynes, rate of interest is determined by the demand for and supply of money. The demand for money depends on the desire of the people to hold money. There are basically three motives for which people want to hold money. These three motives are

i) Transactions Motive: People earn their income at the end of a certain period of time. So to meet the daily transactions during that period of time, people hold money.

ii) Precautionary Motive: In order to safeguard against the future uncertainties, people want to hold money.

iii) Speculative motive: In order to earn more money from the use of money, people want to hold money. According to Mr. Keynes, People want to hold money to buy bonds. When people expect to get more return from the purchase of bonds, they invest the money in the purchase of bonds.

3) Government Expenditure: The government can spend money either on consumption or on investment. When government spends money on consumption by giving unemployment allowances or social security, the purchasing power of the people increases. This leads to rise in demand, price, profit, investment, production and employment. Again, when the government spends money on investment, production and employment increases.

Conclusion: According to Mr. Keynes, there are many factors on which employment depends. Of these factors, consumption is not very active in the determination of employment, because in the long run consumption remains more or less constant. Government expenditure does not depend on the economic policy of the country. It generally depends on the political policy of the government. So it is outside the scope of economics. The rate of interest also remains constant. Hence it is the marginal efficiency of capital, which goes on fluctuating, actually determines employment.

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