The General Theory of Employment Essay Example | Topics and Well Written Essays - 1500 words

The General Theory of Employment - Essay Example His definition of involuntary unemployment, based on response to an increase in aggregate demand led to his definition that full employment is "a situation in which aggregate employment is inelastic in response to an increase in effective demand for its output." (Chapter 3) In Keynesian theory capitalism has no machinery to guarantee full employment. Keynes assumes that when aggregate demand is outweighed by aggregate supply then output will serve as the self-adjusting mechanism. (Furstater, 2001, p. 4) There is "no self-adjusting mechanism which generates a level of effective or aggregate demand sufficient to ensure the full utilization of resources." (Pilling, 1986, p.5) This creates an environment where the possibility of unemployment always exists. This conclusion is repeated by Furstater (p. 10) who states that "capitalism is first and foremost a system that does not provide employment for every person willing and able to work." According to Keynes the level of employment is directly related to the level of output which fluctuates based upon the level of effective demand. The two key components of effective demand are consumption and investment. Consumption refers to the money spent by individuals on consumer goods. As income increases so does our demand for consumer goods, though not quite as much as our income, due to increased taxes and the possibility of our putting the money away in savings, and Keynes referred to this as the marginal propensity to consume. He developed an equation which expressed how much extra will be consumed with the each additional unit of additional income: Marginal propensity to consume= The amount consumption rises The amount income rises mpc (marginal propensity to consume) =dCw dYw (Rodda, p. 2) If savings are increased too much there is a chance that consumption will drop, leading to decreases in income. Keynes believed that if incomes rose the marginal propensity to consume would drop. "When income rose beyond a point where a level of sufficient comfort had been attained, marginal consumption would fall as a greater portion of income is saved." (p. 3) Investment refers to money spent by enterprises on investment goods. "Investment spendingis driven by expectations of future profits." (Taylor, 8) Profits are the revenue that remains after subtracting costs. So investment is based on projected revenue based on expectations of future costs. Whereas consumer spending is fairly predictable, investment spending is volatile. This led Keynes to note that economic downturns were due in part to "the uncontrollable and disobedient psychology of the business world." (Chapter 22) Output is made up of consumer goods and investment goods. The levels of consumption and investment directly affect the level of output. Any fluctuation in the level of effective demand directly, by affecting output levels, affects employment, with a fixed money wage. It must be remembered that the money generated by production is subject to three leakages: taxes,