Question

According to Keynes's theory, unemployment will be temporary because of normal economic fluctuations. Full employment conditions will occur in the long run so that Keynes's theory is the same as the classical thought regarding labor. Discuss this!

Answer 1

The Keynesian view of long-run aggregate supply is different. They argue that the economy can be below full capacity in the long term. Keynesians argue output can be below full capacity for various reasons:

• Wages are sticky downwards (labour markets don’t clear)

• Negative multiplier effect. Once there is a fall in aggregate demand, this causes others to have less income and reduce their spending creating a negative knock-on effect.

• A paradox of thrift. In a recession, people lose confidence and therefore save more. By spending less this causes a further fall in demand.

Demand deficient unemployment

Because of the different opinions about the shape of the aggregate supply and the role of aggregate demand in influencing economic growth, there are different views about the cause of unemployment

• Classical economists argue that unemployment is caused by supply side factors – real wage unemployment, frictional unemployment and structural factors. They downplay the role of demand deficient unemployment.

• Keynesians place a greater emphasis on demand deficient unemployment. For example the current situation in Europe (2014), a Keynesian would say that this unemployment is partly due to insufficient economic growth and low growth of aggregate demand (AD)

• Keynesians support the idea that there can be a trade-off between unemployment and inflation.

• Keynesian model makes a case for greater levels of government intervention, especially in a recession when there is a need for government spending to offset the fall in private sector investment. (Keynesian economics is a justification for the ‘New Deal’ programmes of the 1930s.)

• Keynesian economics suggests governments need to use fiscal policy, especially in a recession. (This is an argument to reject austerity policies of the 2008-13 recession.

• The Keynesian view suggests that government borrowing may be necessary because it helps to increase overall aggregate demand.

Keynesian economics is based on two main ideas. First, aggregate demand is more likely than aggregate supply to be the primary cause of a short-run economic event like a recession. Second, wages and prices can be sticky, and so, in an economic downturn, unemployment can result.

The coordination argument states that downward wage and price flexibility requires perfect information about the level of lower compensation acceptable to other laborers and market participants.

The expenditure multiplier is a Keynesian concept that asserts that a change in autonomous spending causes a more than proportionate change in real GDP.

A macroeconomic externality occurs when what happens at the macro level is different from and inferior to what happens at the micro level.

• Keynes has given a new approach, i.e.,Macro-approach to the field of economics.His theory has several names: theory of income and employment, demand-side theory, consumption theory, and macro-economic theory.

• Keynes’ theory has completely demolished the idea of full-employment and forwards the idea of under-employment equilibrium.He states that employment level in the economy can only be increased by increasing investment.

• Keynesian theory has played a vital role in the economic development of less-developed countries.

• He rejected the theory of wage-cut as a means of promoting full-employment.

  Criticism

  • Keynes theory is a depression theory, which has limited applications.

  • Keynesian theory is not as much dynamic and it may more properly be called comparative statics.

  • Keynesian theory has ignored microanalysis and is not helpful in the solution of the problems of individual firms and consumers.

  • Keynes has not given any place to the accelerator principle.

  • It pays excessive attention to money in economic analysis.