The Keynesian Critique of the Classical System - PowerPoint Presentation

1. The Keynesian Critique of the Classical System Adam smith, credited by many as the founder of classical economics believed the government should intervene in economic affairs as little as possibleJohn Maynard Keynes asked, “If supply creates its own demand, why are we having a worldwide depression?”John Maynard Keynes advocated massive government intervention to bring an end to the Great Depression11-30Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Keynesian EconomicsThe Great Depression of the 1930sKeynes and Keynesian EconomicsKeynes (1936), General Theory of Employment, Interest and Moneythe capitalist economy is inherently unstable and likely to achieve equilibrium with considerable unemployment or severe inflation, and the possibility of persistent unemploymentCopyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIverSlides prepared by Muni Perumal, University of Canberra, Australia

3. Effective DemandPRINCIPLE OF EFFECTIVE DEMAND is the pillar of keynesian theory of employmenteffective demand is that level of aggregate demand at which it is equal to aggregate supply.effective demand is expressed by aggregate expenditure of an economyad refers to aggregate demand expenditure in an economy.it refers to the amount that all the people of an economy may spend on buying goods produced at a given level of employment.

4. What is Effective Demand? In other words, effective demand is the signification of the equilibrium between aggregate demand (C+I) and aggregate supply (C+S). This equilibrium position (effective demand) indicates that the entrepreneurs neither have a tendency to increase production nor a tendency to decrease production. It implies that the national income and employment which correspond to the effective demand are equilibrium levels of national income and employment. Unlike classical theory of income and employment, Keynesian theory of income and employment emphasizes that the equilibrium level of employment would not necessarily be full employment. It can be below or above the level of fullemployment. 

5. Aggregate DemandAggregate Supply Interaction of Aggregate Supply and DemandOutput(GDP)Employment and UnempoymentPrices and InflationForeign TradeMonetary PolicyFiscal Policy Other FactorsPrice leveland CostsPotentila OutputCapital, Labour,Technology

6. ADFAggregate Demand Schedule or Aggregate Demand Function: It refers to the entire table showing producer’s maximum expected receipts from the sale of their output corresponding to various levels of employment.AD=f(N)Level of Employment (in Lakh)Aggregate demand price (ADP) in crore rs.0102030405060100360420480540600660

7. ADCAggregate Demand Curve (ADC):It is a curve which expresses relationship between aggregate demand price and employment.ADExpected ReceiptsEmploymentOXY

8.  Aggregate Supply (C+S):  In other words, the aggregate supply is the value of final output valued at factor cost.The aggregate supply price is the minimum amount of money which the entrepreneurs must receive to cover the costs of output produced by the employment of certain number of workers.The aggregate supply curve, (C+S) is positively sloped indicating that as the level of employment increases, the level of output also increases, thereby, increasing the aggregate, supply. Thus, the aggregate supply (C+S) depends upon the level of employment through the economy's aggregate production function. 

9. Aggregate Supply Schedule /Aggregate Supply Function (ADF):It is a schedule/Table which shows various amount of money which all the producers must receive from the sale of output at varying levels of employment.Level of EmploymentAggregate Supply Price (crore rs)01020304050600120240360480600720

10. Y Aggregate Supply CurveAS=f(N)Minimum Expected ProceedsEmploymentASCXY

11. EmploymentAD(crore rs)AS (crore rs)Equilibrium01020304050601003604204805406006600120240360480600720DisequiAD>ASAD>ASAD>ASAD>ASEDAD<ASDetermination of Effective DemandExpected ReceiptsEmploymentXYEEffective DemandADASO

12. Aggregate Demand Exceeds Aggregate SupplyWhen aggregate demand exceeds aggregate supply the economy is in disequilibriumOutput is increased in responseEventually, the economy approaches full capacity followed by price increasesIt appears that there are two ways to raise aggregate supplyBy increasing outputBy increasing pricesBy doing this, aggregate supply is raised relative to aggregate demand and equilibrium is restored11-43Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

13. Aggregate Supply Exceeds Aggregate DemandWhen aggregate supply exceeds aggregate demand the economy is in disequilibriumInventories rise and output is decreasedWorkers are laid off, further depressing aggregate demand as these workers cut back on their consumptionEventually, inventories are sufficiently depletedIn the meantime, aggregate supply has fallen back into equilibrium with aggregate demand11-44Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

14. Determination of Level of Employment and Income: According to Keynes, the equilibrium levels of national income and employment are determined by the interaction of aggregate demand curve (AD) and aggregate supply curve (AS). The equilibrium level of income determined by the equality of AD and AS does not necessarily indicate the full employment level. 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. Diagram/Figure:  

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16. Keynesian Theory