macro unit 1

8/6/2019 Macro Unit 1

1/40


2/40

ECONOMICS- POINT

2 | P a g e

a) Formulation of economics policiesb) Understanding micro economyc) Functioning of an economy systemd) Understating and controlling economic fluctuationse) Study of economic developmentf) Inflation and deflationg) Study of national incomeh) Performance of an economyi) Nature of material welfare

a) Formulation of economics policies: it helps in the formulation of economic policies. Such asmonetary and fiscal policies during the inflationary and deflationary situation to solve the

problems of rise in prices, unemployment, depressions etc.

b) Understating micro economy: the study of macro economics is essential for properunderstating of micro-economics. Without macro-economic no micro-economic law are

studied. For example the theory of individual firm could not have been formulated without

reference to behavior pattern of general industries. So macro-economic is treated as jungle

and micro-economic as tree.

c) Functioning of an economy : it is utmost important in getting us an idea of the functioning ofan economy system. It is very essential for a proper and accurate knowledge of the behavior

pattern of the aggregate variables. Without macro economics we are not been able to know

what type of economy system is there i.e. socialism, capitalism, or mixed economy.d) Understating and controlling economics fluctuation : the theory of economics fluctuations

can be understood and built up only with the help of macro economics, for here , we have

to take into aggregate consumption, aggregate saving and investment in the economy.

e) Study of economic development: as a result of advanced study in macro economics, it hasbecome possible to give more attention to the problem of development of underdeveloped

countries. The main aim of macro economy is to promote economic welfare.

f) Inflation and deflation: Macro-economic approaches are of utmost important to analysisand understand the effects of inflation are affected differently as a result of changes in the

value of money. Macro-economic enables us to take certain steps to counter attack the

adverse influences of inflation and deflation.

g) Study of national income: it is the study of macro-economic which has brought forward theimportance of study of national income and social accounts. With help of national income

we are in a position to know which country is developed and which is not. Again, with help

of the national income correct economic policies been formulated.


3/40

ECONOMICS- POINT

3 | P a g e

h) Performance of an economy: macro-economic helps us to understand and analysis helps usto understand and analyses the performance of an economy. It implies result oriented study

of an economy in terms of actual and factual achievements.

i) Nature of material welfare: macroeconomic enables us to study the nature and size of thematerial welfare of the nations, the problem of measuring the social welfare is not easy,

even welfare economy does not help us at that time , we take the help of macro economics.

Limitations of macro economics:

Macro-economic analysis is very useful in studying the national problems that is the problems

related to the whole economy but there are certain limitations too, these limitations are in the

nature of particle difficulties in formulating meaningful aggregates. The main limitations are:

a) False generalizationb) Difficulties in measuring the aggregatesc) Diversities

a) False generalization:The aggregate approach draws the conclusion of macro level studies, this generalization results

are confusing because in macroeconomic we proceed from general to particular. So

generalization the conclusion is dangerous, irrelevant and misleading.

b) Difficulties in measuring the aggregates :Macro economy analysis is not possible without a common measuring rod. Before the money

been invented, meaningful aggregates were difficult to find out due to heterogeneous elements

and also changing in the value of money.

c) Diversities:The aggregative conclusion shows an average tendency and therefore do not influence all the

sectors alike. Some sectors may be possible saw a difference tendency. For example arise in

general price level, may not affect all the sectors in the same way . some may have favorable

effect while some other may be adverse effect.

Conclusion:

From the above discussion it shows that limitations associated with the macro economics

analysis affect only its practical signification, however they in way invalidated. in

macroeconomic techniques.


4/40

ECONOMICS- POINT

4 | P a g e

2. What do you mean by circular flow of income & expenditure ? Explain it with Help of the two

sector, three sector & four sector model?

A. Circular flow means continuous circular movement of money and goods in the economy. Theconcepts of circular flow of income is a simplification of which attempts to explain and show the

flow of money and goods from household to b usiness enterprises and back to household. Circular

flow o money means that the money spent must not be hoarded and should contribute to flow to

maintain a certain level of economic activity and income.

We may explain it symbolically that is NNP=NNY=NNE . This concept was first time developed by

j.m. Keynes . He said that saving is always equal to investment .

The circular flow of income & expenditure refers to the process where by the national income &

expenditure of an economy flow in a continuous manner over a long period of time. The various

components of national income & expenditure . Such as:- saving , investment, taxation, Govt. ,

expenditure, export, import etc.

We may explain circular flow of income & expenditure in three different ways . such as :-

y Two sector modely Three sector modely Four sector model

Two sector model:-

In the two sector model , there is only two sectors. One is household sector and another is businesssector.

i. Household sector:-Household sector owns all the factors of production. That is labour , land, & capital. This

sector receives income by selling the services to the business sector.

ii. Business sector:-Business sector consists of producers who produce product and sell them to the

household sector or consumers.

Thus the household sector buys the output of product of the business sector. In return business

sector demands the factor market from the household sector.

We may explain it with help of the following chart.


5/40

ECONOMICS-

OINT

5 |P a g e

Cons

on Expenditure

Product Market

BusinessSector House old Sector

Factor Market

Income Payments

In the above figure left hand side indicates the business sector and right hand side indicate the

household sector. Household sector provides the factor market to the businesssector. With help of

factor market (Land, Labour, Capital) business sector produce the goods and services which is

technically known as product market. Household sector consumes the goods from the businesssector that is the consumption expenditure of household sector . Business sector receives the

income in form of consumption expenditure and pays the income payment to the household

sector. With help of that household sector again demands goods and services from the business

sector . Businesssectors again demands factor from the household sector. In this process income

and expenditure flow continuous.

Ci

ul

flo

withs

in

s andin

st

nt add

d:-

Actually in our economy two important elements are there. Those element are saving and

investment or they are inflows and leakages. Saving in the leakages and investment is the inflows or

injection.

We mayexplain it with help of the following flow chart.


6/40

ECONOMICS- OINT

6|P a g e

Investment Capital Market Saving

Consumption Expenditure

Product market

Businesssector Household sector

Factor Market

Income Payments

In the above flow chart saving comes from the household sector. That saving will invested in the

capital market. Businesssector receives the investment from thecapital market for producing the

goods and services. Expenditure has two alternative paths that is directly via. Consumption

expenditure . Second one is indirectlyvia. Investment expenditure .

Saving Capital Market Investment is the directlyvia. Consumption expenditure.

On the other hand Investment capital market Saving is known as indirectly via.

Investment expenditure .

( capital market means the financial institutionssuch as :-commercial bank, Financial Institutions ,

saving Bank etc.)

In simply the households supply saving to the capital market and the firms, in turn obtain the

investment funds from thecapital market.

h

s

to Mod

l:-

In three sector model, there are three sector exist in an economy. Such as :- household sector,

businesssector & Govt. sector.

Ci

ular flow ofhous

hold and Go

t ! s

tor :-

Whilestarting the threesector model first we take thecircular flow between the household sector

and the Govt. sector . There are two important inflows & leakages . Those are :- taxes & Govt.purchases.

Taxes in the form of personal income tax & commodity tax paid by the household sector are

outflows or leakages from the circular flow. But the Govt. purchases the services of the

households, makes transfer payment in the form of old age pension , unemployment relief, sickness

benefit etc are the injection or inflows of thecircular flow.


7/40

ECONOMICS- " OINT

7|P a g e

Circular flow between businesssector & Govt. sector :-

All types of taxes paid by the businesssector to the Govt. are leakages. On the other hand Govt.

purchase all its re#

uirements of goods of all types from the business sector , give subsides andmakes transfer payment to firms in order to encourage their production iscalled injection.

Household, Govt. ,businesssector taken together :-

We know that taxation is a leakages from thecircular flow. It tends to reduceconsumption &saving

of the household sector. Reduceconsumption in turn reduces thesales and income of the firms.

On the other hand taxes on business firm tend to reduce their investment & production. The Govt.

offsets these leakages by making purchases from the business sector and buying services of the

household sector e # ual to the amount of taxes. In this waycircular flow of income&expenditure

remain in e#

uilibrium.

We mayexplain it with help of the following flow chart.

Government Government

Purchase sector

Taxes

Investment Capital market Saving

In the abovechart it shows that taxes flow out of the household and businesssector and go to theGovt. The Govt. makes investment and for this purchases goods from firms and also factors of

production from households, There fore the Govt.purchases of goods and services are injection in

thecircular flow of income and taxes are leakages.

If Govt. purchases exceed , net taxes then the Govt. will incur deficit e # ual to the difference

between the two. That is Govt. expenditure and tax. The Govt. finances it deficit by borrowing from

thecapital market which receives funds from household in the form ofsaving. On the other hand if


8/40

ECONOMICS- POINT

8 | P a g e

net taxes exceeds Govt. purchases the Govt. will have a budget surplus. In this case the Govt.

reduces the public debt & supplies funds to the capital market which are received by firms.

Import ants of the circular flow of income & expenditure: -

The concept of circular flow gives a clear-cut picture of the economy. By this we may know which

country is economically developed or not. Or in other words it indicates the working efficiency &

the disturbances in its functioning. It is very helpful in case of disequilibrium in the economy system

. In modern time it explains the role of leakages and their impacts on national income accounting .

It helps to Govt. to adopt proper measure to control & increase the import & export. The study of

circular flow also highlights the import ants of monetary policy to bring about the equality of saving

& investment in the economy. Similarly , the circular flow of income & expenditure points towards

the importance of fiscal policy.

From the above discussion it shows that circular flow of income & expenditure play an important

role in national income accounting. With out it we are not bee n able to know the exact economic

system of that country or nation. So , one of the greatest economist said it is the nervous system of

economy.

Q.3 What is national income? Explain its various method of measuring national income and its

difficulties ?

Introduction:- Concept of national income occupies a very important place in the Keynesian theory

of employment .Generally ,national income means income of the nation or it is the summation of

pre capita incomes. The concept of incomes from the very basis of the Keynesian theory of

employment. As a matter of fact, we can take income output and employment as equal to each

other. If income and output increases than employment also increased.

For the sake of simplicity and easy Keynes adopted a short period analysis . in which organization,

equipment and techniques assume are given.

Definition:- Different economist define national income in different ways.

According to Marshal, The labour and capital of a country, acting on its natural resourcesproduce annually a certain net aggregate of commodities. Material and immaterial

including services of all kind and net income due on account of foreign investments must

be added in. This is the true net annual income and revenue of the country or the national

davidant


9/40

ECONOMICS- POINT

9 | P a g e

According to Pigue , The national davidant is that part of the objective income of thecommodity including of course ,income divided from abroad, which can be measure in

money

According to Fisher, The national davidant or income consist of services as received byultimate consumers, whether from material or immaterial goods

According to Keynes, National income means all final goods and services which areproduced during a given period of time with in the country and abroad.

From above the definitions , it shows that national income simply income of the nation it comes

from consumption , investment, Govt., net export , net factor income from abroad. The national

income can be expressed in national product , national income, national expenditure .

NY=C+I+G+(X-M)+(R-P)

NY=national income , C= capital , I= investment , G = govt. , X= export , M=import, R= receipt ,

P=payment

National product :-National product means al the final goods and services which are produced

during a given period of time is known as national product. It means in this case we have take all

the three sectors final product with out duplication. Then we will get net national product .

National Income :-national income means all the income received by various factors of production

during a given period of time in the form of wage, rent, interest, profit etc.

National Expenditure:- National expenditure means the sum of expenditure of final consumption

of goods and services pulse domestic and foreign net investment .

Above three concepts are identically to each other . we may express it in following manner .

NNP=NNY=NNE

NNP=Net National product , NNY= Net National Income , NNE=Net National Expenditure

Methods of measuring National Income:-

The method of national income of the country depends upon the availability of statistics. Followin g

are the methods which are generally used us follows .

i. Product Method ii. Income Method

iii. Expenditure Methodiv. Social Accounting Method


10/40

ECONOMICS- POINT

10 | P a g e

v. Combined Method Product Method:-

Product method otherwise known as commodity service method. In this method we find out the

market value of all goods and services produced in a country during a given period of time. In this

method we estimate all the final goods and services from primary sector , secondary sector and

service sector. The total of estimates gives us net domestic product from market price and factor

cost.

Income Method :-

This method consists in wage + rent+ interest + profit .

Expenditure Method : -

Expenditure method means all the expenses during a given period of time . Under this method we

add personal consumption expenditure , gross domestics income, Govt. goods and services and net

factor income from abroad. The three methods of measuring national income gives us the same

result . This equality of national income due to the three flows . Such as income ,output and

expenditure.

Social Accounting Method : -

This is new method . this method was developed by Richard stone . According to the social

accounting method various types of transaction are classified in different groups. Producer, traders,

final consumers etc.

Combined Method :-

It is not possible to estimate correctly the national income by adopting a particular method. Each

method has its own weakness. To solve these weakness modern economist used mixed combined

method for estimating national income. This type of method is used in under developed countries

and developing countries. In India this method was used in 1948 -49 by national income committee.

Difficulties / Problems of measurement ofNational Income : -

There are so many difficulties to calculate or to measure the national income . Those are : -

Difficulty in defining nation : -These is the difficulty of define Nation in national Income, Generally , nation means a

define territory or boundary, but in economic way it is differ . It is not only explain the

income with in the country but also explains outside the country.

It only take into monetary forms:-


11/40

ECONOMICS- POINT

11 | P a g e

National income is always measure in money. There are some other goods and services

which are difficulty to measure in terms of money. For example :- Teachers services ,

painting etc.

There is a difficulty in double counting : -Double counting means we count the goods & services in primary stage as well as in the

final stage . In measuring national income if we can take this type of method than our

national income will be doubled . so solve this difficulty only the final goods and services

are taken into account.

Difficulty in including transfer payment: -Transfer payment means the payment of the Govt. to the general citizens in terms of

pension, unemployment allowance etc. If this included national income there is a difficulty.

Problem in to calculate depreciation : -Depreciation means wear and tear charges. Depreciation charge on profits which lowers

national income . When the price of capital goods are changing than the profit also

changes.

G.N.P Deprecation =N.N.P

Money is not an measuring rod :-The calculation of national income in term of money is under estimation of real national

income . we know that real national means the population of countries stable / constant , if

there is increase in the national income then we may say our real national income

increases. But our economic planners estimate national income in the form of money only.

In under developed & developing countries most of the sector are unorganized :-In underdeveloped & developing countries most of the sectors are unorganized. It meansthe income of each and every sector is not proper.

Non availability of Data:-

Adequate and correct production and cost data are not available in a developing and

underdeveloped countries . in underdeveloped and developing countries the peoples are

not maintain proper account.

IL-Literacy:- In developing and underdeveloped countries most of the peoples are il -literate and

educated. For that reason they does not maintain any proper account.

Conclusion:-

From the above discussion it shows that national income estimation play on important role in

macro economy. From the national income estimation we know that whether the country is

developed, developing, under developed . At present our growth rate or G.D.P rate is 8.5 but, it

was 0.5 in the year of 1950-59. Generally , the national income estimated by the planning

commission and central statistical organization and national sample survey .


12/40

ECONOMICS- POINT

12 | P a g e

Unit -2

Q.1 Discuss the basic assumptions of classical Economics?

A. Introduction: - The classical economics is a well knit body of economic doctrines which has been

handed down from generation to generation since the days of an English economist sir. David

Ricardo. By classical economist Keynes means that the traditional or orthodox principle of

economics. The principles of David Ricardos and Adam Smith are modified by the J.S. Mill and

Pigou. The basic principles of classical economist were generally accepted for a long period of time.

They strongly believe in full employment.

Following are the some of the important assumption of classical economist or contents of classical

economics. Those are: -

i. Assumption of full employmentii. Allocation of Resourcesiii. Philosophy of Laissez faire policyiv. Importance of Rate Of Interestv. Says Lawvi. Role of Moneyvii. Wage cut Policyviii. Automatic Adjustmentix. Long run Equilibriumx. Partial Equilibrium

Assumption ofFull Employment:-

By the term full employment means utilizing the natural resources in an optimum manner. It is the

important assumption of classical theory. They always believe in full employment situation. To

them full employment is an abnormal situation. According to them, if there is less than full

employment in the economy there is always a tendency towards full employment. According to

them, There is involuntary unemployment.

Allocation Of Resources :-

Classical felt that there could not be any significant mall allocation of resources as the pricemechanism acting as an invisible hand and would achieve the best and most efficient allocation of

resources. Since, the optimum allocation of a given quantity of resources was the main subject

matter of classical economist. In brief , the well known theory of value , distri bution and production

formed the care of the classical economist.


13/40

ECONOMICS- POINT

13 | P a g e

Philosophy Of Laissez Faire :-

Classical had great faith in the philosophy faire of capitalism which means live alone or left alone in

business matter. It means, state should not be interfere in the economic matter. Classical believedin laissez faire capitalism are equal the traditional model of study from the very begging . they have

great faith in price, mechanism, profit motive, free hand perfect competition, the self existing

nature of the system. They felt that if the system is allowed toward freely economic development is

possible.

Importance Of Rate OfInterest : -

Rate of interest occupies a very important place in the classical system. It is treated as the

equilibrating mechanism between saving and investment. Because, it brings equality between the

two.

Says Law:-

Another essential element of classical economics is says law of market. The says law of market is

the heart of the classical system. Says law of market states that supply creates its own demand. In

the other word, According to J.B.Say, there cannot be general over production or general

unemployment on account of the excess of supply over demand. Because whatever is supplied or

produced is automatically exchanged for money. So, there is no ground to fear a break in the flow

of income stream in the economy hence, there cannot be any general over production or

unemployment.

Role Of Money:-

In classical system the role of money is very limited. They only taken into account money as a

medium of exchange and ignore the other important function of money. They assume that people

have only one motive for holding money that is transition motive. They completely ignore the

precautionary and speculative motive for holding money.

Wage Cut Policy:-

Classical further believed that involuntary unemployment could be easily solved by cutting wages

down as a result of free and perfect competition which always exist in labour market. Classical s

believed that employment is determined by the wage hoarsens between the workers and employs;

therefore, wage cut will reduced unemployment. This concept was first time propounded by

A.C.Pigou. It occupies a central place in the classical scheme of reasoning.


14/40

ECONOMICS- POINT

14 | P a g e

Automatic Adjustment :-

According to classical s there is automatic adjustment in the forces of demand of the forced of the

supply are self existing of full employment level. They believed in the elasticity of the economicsystem. If there any obstacles in self existing automatic mechanism, the invisible hand (current

price mechanism) takes care of the difficulties. Classical s believed that flexible price, wage, interest

system etc set things rights to bring about automatic adjustment.

Long term Equilibrium :-

The another important assumption of classical economics is the long term analysis. They strongly

believed in the long run and in long run supply automatically creates its own demand. So, their

equilibrium analysis is long term equilibrium analysis.

Partial Equilibrium:-

Classical equilibrium is partial equilibrium and not a general equilibrium. Its loss and generalization

applied to a firm or an industry. But, not to the economic system as a whole. For example: - Pigous

wage cut is only applicable to a particular firm or industry but, it is not applicable to whole

economic system.

Saving:-According to them saving is great private and social virtue. They thought that saving helps

the capital formation that capital formation help in the economic development.

Keyness reaction on classical assumption or Keynes attack on classical s :-Keynes did notagree any one of the classical assumption and there policy implication. Keynes criticizedeach and every point of classical s according to Keynes the classical theory is a neatly the

logical of the basic of its assumption. But, this assumption is highly unrealistic.

Following are some of the important limitation of class ical system. Those are :-

I. Full employment is a myth.There is a chance of wastages of resources.

II. There is no invisible hand.III. Rate of interest in not an equilibrium mechanism.IV. Supply never creates its own demand.V.

Wage cut is not a proper solution.

VI. Long run analysis is not an opportunity for economic system.VII. There is a general equilibrium.

VIII. Saving is not virtue hut, it is a vice versa.


15/40

ECONOMICS- POINT

15 | P a g e

Q2. Supply creates its own demand comments this statement?

Or

Critically examine the says law markets and how Keynes critics it?

Or

What is says law of market? Does it stand its invalidity?

Introduction:

Says law of market is the core of the classical theory of employment. J.B.Say an earlier 19th

century

France economist propounded this concept. According to his name it is treated as the says law of

market. In the words of says, it is production which creates markets for goods. A product is no

sooner created than it, from that instant affords a market for other products to the full extent of itsown value. Nothing is more favorable to the demand of one product, than the supply of another.

In its original form the law is applicable to a barter economy where goods are ultimately sold for

goods. Every goods brought to the markets is a demand for some other goods.

Say argued that since work is unpleasant, no person will work to make a product unless he wants to

exchange it for some other product which he desires.

Therefore, the very act of supplying goods implies a demand for them. In such a situation there

cannot be general over production because whatever may be produce will automactilly demanded

by the people. So supply creates its own demand. But for the single product there is

overproduction.

This concept strongly supported by the J.S. MILL, DAVID RICARDO, and A.C. PIGOU.

Assumptions of says law of market:

Following are the some of the important assumptions of says law of market:

Perfect competition More opportunities Wide extent of market No state intervention Flexibility of prices Money mistaken belief Long period No hoarding Consumers sovereignty


16/40

ECONOMICS- POINT

16 | P a g e

Explanation of the law:

Says law of market can be explained in three different ways, these are:

With help of saving and investment Quantity theory of money Pigous version1. With help of saving & investment: The says law of market can be explained with help of

saving and investment equality. If there is any inequality between them that will

automatically equalized by rate of interest? To the classist interest is a reward for saving,

higher the rate of interest higher the saving & lower the rate of interest lower the saving.

On the contrary, lower the rate of interest, higher the demand for investment funds and

vice-versa.

J.B. SAY explained the above statement in following figure:

In the above figure in OX-axis we measured saving and investment and in OY-axis rate of

interest. II is the investment curve and SS is the saving curve. Saving curve is the increasing

function due to as rate of interest increases, saving also increases. If rate of interest

decreases then saving also declines. So the saving curve upward sloping curve.

On the other hand if rate of interest increases, investment declines because it is the

decreasing function. So the investment curve downward sloping curve.

According to classical economist, the point in which both SS & II intersect to each other that

is the point of equilibrium. In the above figure point E is the point of equilibrium.

Suppose , if there is any increase in investment than the investment curve will shift to II to

II

and the equilibrium point also shift to E to E. This is the instable equilibrium point

because once the investment increases then the rate of interest also increased to OR to OR.

Once rate of interest increases then the equilibrium position will again come back to the

original equilibrium position. For our convince we have given the name E

with the original


17/40

ECONOMICS- POINT

17 | P a g e

rate of interest. For that reason classist thought that rate of interest is a mechanism which

can solve the problem of saving and investment inequality.

2. Quantity theory of money:The validity of says law of market in a money economy depends upon the QTM. QTM states

that price level is a function of the supply of money.

MV= PT

M = supply of money

V = velocity

P= price level

T= transaction.

The equation tells that the total money supply (MV) equals to total value of output (PT). In

the economy V & T are assume to be constant. We know that the transaction of money is

based on the money as a medium of exchange. If we want to prove the validity of says law

of market, we must and should explain the QTM theoretically as well as diagrammatically.

Now let us discuss the QTM with helps of following diagram.

In the mentioned two figures represents the output and prices and the figure B represents the

money wage and price level. In figure A price level is taken on OX-axis and output is taken on OY-

axis. MV is the money supply curve which is rectangular hyperbola. This is because the equation is

MV=PT holds on all points of this curve. Given the output level OQ, there would be only one price

level i.e. OP. OP consistence with the QTM as shown by point M on MV curve.

If the QTM increases MV to M1V1 then the price level also increases to OP to OP1, Given the same

amount of output i.e OQ. In this case rise in the price level is exactly proportional to the rise in the

quantity of money i.e PP1 equivalent to MM1.

In the fig B determines the price level with help of the totalQTM MV and the total output of OQ. It

is possible to determine the money wage consistent with a given real wage. W/P is the real wage

line which is an increasing function (or) it is given, when the price level is OP1 money wage is OW.


18/40

ECONOMICS- POINT

18 | P a g e

When price level raises to OP1 the money wage also rise to OW1. The wage price combination is

OW1=OP1 is consistent with the full employment real wage level W/T.

3.PIGOUS

VERSION:

Classical theory of employment (Says law of market) received its final version at the

hands of pigou who formulated Says law in terms of labour market. Acc to Pigou, under free

competition, the tendency of economy system is too automatically and it provides the full

employment in the labour market.

Acc to him unemployment arises due to wage rigidity or stat4e intervention in the

economic matter. If the state interferes in the economic matter then he recognized the

trade unions and also passed the minimum wage act. This will leads to like in the money

wage which results unemployment situation in the economy. If state not interferes in the

economic matter then there will be no problem for unemplo yment situation in the

economy.Symbolically, N=qy/w, whereas,

N= the number of workers employed.

Q=the fraction of income earned.

Y=national income

W=Money wage

N can be increased by a reduction in wage, thus the key to full employment is a

reduction in money wage. We may explain it w ith help of the following figure.

In the fig A, DD is the demand for labour and SS is the supply for labour, both curve are intersected

to each other at the point E, E is the point of full employment with ow/p money wage ON F

employee are engaged. If there is any increase in the real wage rate i.e w/p to w/ p1 then

employment reduced to NF to No and there is an unemployment situation been created in the

economic system. Because the SS>DD. Once the situation arises the producers declares the wage

rate and automatically unemployment situation vanished from the economy.


19/40

ECONOMICS- POINT

19 | P a g e

In the fig B, MPL is marginal productivity labour curve which is downward sloping, it

indicates that higher the wages, lower will be the employment n vice versa. Acc to Pigous if

the MPL is high then he or she will get more wages. If the MPL is low then he or she will get

low wages. The point in which MPL and w/p intersect to each other that point is known as

full employment.

IMPLICATION OF SAYS LAW:

Following are the implication of says law those are

automatic adjustment, no general over production, more employed to unemployed resources, flexible rate of interest and wage rate, money as a veil, no general unemployment, production is more important than consumption, Free trade.

CRITICISMS:

As the depression of 1929, the depend and several years passed without sign of recovery,

says law was called into question in 1936, J.M.Keynes and most of the economist at that

time doubted about the says law of market and its validity. On this background, D.H.

Robertson and M.S Sweezy strongly criticized the says law of market. The classical theory of

income and employment or says law of market. It has been criticized by J.M. Keynes on the

following grounds: Possibility of deficiency of effective deman d Possibility of general over production and unemployment Fallacy of aggression Prolonged depression Wage cut is not the proper solution Importance of short run is ignored Unrealistic assumption Underemployment

Conclusion:

From the above points it is clear that the classical model had an inconsistency. It tried to separate

the real sector from the monetary sector. The pricing process in the real sector was separated from

that in the monetary sector through the assumption of neutrality of money. This separation was

invalid as it did not have a link between the goods market and the money market.


20/40

ECONOMICS- POINT

20 | P a g e

Unit-3

Q1. Compare and context between the classical and Keynes theory & explain which is superior

and why?

Or

Is Keyness revolutionary or evolutionary? Comment this statement?

Or

Compare & context between classical theory & Keynesian theory of income & employment? And

how Keynes proves that classical theory is outdated?

Introduction:

In the history of economics in 1930 was the most turbulent decay that set off the most rapid

advance in economic thought with the publication of Keyness general theory of employment,

interest and money in 1936. Keynes attacked the classical doctrine for its failure to solve the

problem of the great depression. The 1929-30s depression demoralized the faith with left of the

classical doctrine. At that time general theory was born in a favorable situation.

After the publication of general theory and its 25th year of anniversary there has been a public

debate on it. Some says Keynesian system is totally copied or his view is not original on the other

hand some other economist strongly supported general theory and they said that nothing is original

in world and all the ideas of successive creative minds and formulates new ideas on their works and

thought. So, the Keynesian system is totally new and it is a revolutionary as well as the evolutionary

one.

Now, let us discuss what the difference between classical th ought and Keynesians thought are:

View on full-employment View on supply and demand Role of state View on wage cut View on saving View on business cycle View on rate of interest View on economics View on capitalism View on budget system


21/40

ECONOMICS- POINT

21 | P a g e

View on full-employment: the classical believed in the existence of full employment in the

economy and situation of less than full-employment was regarded as abnormal. For this reason

they never thought to have a special theory for the employment.

On the other hand Keynes considered the existence of full-employment in the economy as a

special case for that reason he felt the theory of employment.

View on supply and demand: the classical analysis was based on the says law of market & they

strongly believed supply side economy.

On the other hand Keynesian economy is based on the demand side economy. According to him

demand creates its own supply. On this background prof.Klein said the revolution was solely the

development of a theory of effective demand.

Role of state: the classical economics was based on the laissez fair policy of a self adjustingeconomic system with no govt. intervention.

On the other hand Keynes strongly believed in the state intervention in economic matter.

View on wage cut: to solve the problem of unemployment, classical thought that cut in way is

the proper solution for unemployment. on the other hand Keynes strongly criticised wage cut

policy because it has both theoretical as well as practical problem . it is theoretically is un sound

and practically it is impossible .

VIEW ON SAVING

The classical emphasized the importance of saving for the economic growth. According to

them, saving means not hoarding and it will invest in a productive manner .on the other hand

Keynes said that saving was a private virtue and public vice. it means increase in aggregate

saving leads to a decline in aggregate consumption , that ultimately declines the demand for

goods and services and the final result is decline in the level of employment in an econom y .

VIEW ON BUSINESS CYCLE AND BUSINESS FLUCTTUATION:

The classists artificially separated the monetary theory from the value theory.

On the other hand, Keynes integrated monetary theory and value theory .he alsobrought interest theory into the domain of monetary theory .he regarded the rate of interest as

a purely monetary phenomena .while classical thought that rate of interest is neutral.

VIEW ON ECONOMICS :

The classical economics was a micro economics analysis which relates the problem of individual

consumption; individual production etc. on the hand, Keynesian theory adopted the macro


22/40

ECONOMICS- POINT

22 | P a g e

approach to economic problem. It deals with aggregate consumption, aggregate supply,

aggregate demand, aggregate prices etc. in this background proof Hansen remarked that the

general theory has helped to make us to think of economics in dynamic rather than in static

terms.

VIEW ONCAPITALISM :

Classical believed strongly laissez capitalism. On the other hand, Keynes believed in

capitalism with state intervention.

VIEW ON BUDGET SYSTEM:

The classical economist strongly believed in the balanced budget policy to solve the problem

of inflection and deflation. On the other hand Keynes stresses the importance of deficit budget

during deflation and surplus budget during inflation. For that reason, we may say thatKeynesian system is practically oriented system than that of the classical system.

CONCLUSIONAND CRITICISM:

From the above discussion we may conclude that the general theory is not evolutionary

but is revolutionary in both economic thought and policy and is a genuine departure from the

classical thought.

From the above discussion and its conclusion we cannot say that Keynesian system is the best

system because it has its own weakness and the modern economist criticized Keynesian system

in following ground.

AGGREGATE DEMAND:

In Keynesian economics A.D an important role, but he neglects the possibility that the relative

prices prevailing in the market determines the total amount of output. Again he totally neglects

the Aggregate supply function.

EFFECTIVE DEMAND:

Economists have criticized Keynes principles of effective demand for two reasons. Firstly for

taking the Aggregate supply to be stable .secondly for assuming a direct functional relationshipbetween effective demand and the volume of employment.

CONSUMPTIONFUNCTION:

No doubt , Keynes consumption function is an epoch making contribution to the tools of

economic analysis .but the relationship does not run simply from current income to current

consumption .there are some other functions also there which influences the consumption


23/40

ECONOMICS- POINT

23 | P a g e

function . Those factors are technology, education, attitudes etc. these factors totally ignored

by the Keynes.

Investment function:

Keynes has also been criticized for formulating the functional relationship between investments

and the rate of interest. Again he made his analyses more complicated by introducing the

interrelation between rate of interest and marginal efficiency of capital to determine the level

of investment in his analysis he totally ignored the relationship between capital stock and

investment.

Rate of interest:

The Keynesian theory of interest rate determination has been severally criticized by post

Keynesian economists (modern economists) because while determining rate of interest. He onlytakes into account the speculative motive of demand and he neglect the precautionary motive

and transaction motive and also ignores the supply for money. So question is how the rate of

interest been determined without taking supply of money and other motives and also the rate

of interest govt. by price level.

SAVINGAND INVESTMENT:

Keynes did not pay as much important to saving as to investment in his analysis . Acc. To him

saving is a great social vice and his relationship between saving and investment is much more

confusing.

WAGES:

The Keynesian under employment equilibrium is based on wages rigidity. he also suggested

increased in money wage on reduction of real wage will reduces or remove un employment .

But in partial senses it is impossible said by the modern economists.

SHORT RUN ECONOMICS :

Keynes strongly believed in the short-run. Acc. To him in short-run all the economic problems

will solve. But it is impossible for developing countries.

CLOSED ECONOMY:

The Keynesian theory is based on the assumption of closed economy which excludes the impact

of foreign trade on the level of employment and income. But in modern world all most all

countries follows the open economy system. On this background Keynesian system been

criticized by the modern economist.


24/40

ECONOMICS- POINT

24 | P a g e

PERFECTCOMPETION;

Another weakness of the Keynesian theory is that. it is based on the un realistic assumption of

perfect completion .

GENERAL THEORY:

Keynes considered his theory but a special theory but actually its not as general theory but a

special theory which is applicable only under static condition in a perfectly competitive closed

economy.

PROBLEM OF UNEMPLOYMENT:

Keynes only considers the cyclical unemployment and neglects the other form of

unemployment that is (technological, fractional, structural, disguised) unemployment etc.


25/40

ECONOMICS- POINT

25 | P a g e

Unit-3

Quest; explain the relation between saving and investment theory?

Or

Saving and investment are always equal in equilibrium. Explain this statement?

Or critically examine the ex-ante and ex-post approach to the interrelation of saving and

investment?

Ans; Introduction;

In macro analysis, Keynes saving and investment functions are as important to income analysis as

Marshalls supply and demand curve to price analysis. Another name of the saving and investment

equality is EFFECTIVE DEMAND. It is the fundamental condition of general equilibrium analysis.Saving and investment function arte the two pillars of the Keynesian theory of emplo yment, income

and money. The macro economy is based upon the equality between saving and investment. Lets

discuss now both are equal to each other.

Saving function;

We know that saving is the excess of income over expenditure [S=Y-C].Keynes aggregate supply is

the direct result as defined differently by different economists. Some says saving as the income

earned in a period minus the consumption in the same period. Some other economists said Ex -ante

saving means planned or expected saving of the economy, while Ex-post are observed saving,

whatever may be income increases and the saving also increases. So the shape of saving curve is

upward sloping. But sometimes the saving the saving may negative. For that reason saving curve

sometime intersect the ox-axis.

Now we may explain it with the help of the diagram;

In the above figure SS is the saving curve. It is upward movement. It means as the income increases,

saving also increases. In that curve, there are several points, ABEC. These are the saving points .but

all the points are not observable because some points are below the investment line. II is the

investment line. The point in which SS curve INTERSECT II curve. That is known as the observable

saving or equilibrium point. Because there is the condi tion is that I is always equal to S.


26/40

ECONOMICS- POINT

26 | P a g e

So according to Keynes, saving implies collective or aggregate saving of the community. According

to classical economist, saving as a great private virtue. On the other hand, Keynes says saving as a

social vice.

Now we may explain it with the help of the figure;

The original S and I curve intersect at the point E1 and gives us the equilibrium level of income

OY1.now suppose, saving in the community increases. So that saving curve shift S1 to S2 and thenew equilibrium will be E2.as a result there is a contraction on income, it means the income level

OY1 decreases Y2.in this situation, the incomer of the community decline due to the increase in

saving. So Keynes called saving as a social vice. Because it reduces income, output and employment.

Investment function:

The term investment means the net addition to the existing stock of real capital assets such as

construction of factories, new office buildings etc. generally investment is two types;

Physical investment- Buildings, stocks, factories etc. come under physical investment.

Financial investment-on the other hand shares, bonds etc are come under financial investment. So

in Keynesian sense, he says investment includes both financial and physical investment.

Saving and investment equality:

We may explain the saving and investment equality in two ways. In classical as well as in Keynesian

way. Lets discuss the classical view on saving and investment equality.

Classical view- according to classical view, there is an existence of full employment where saving

and investment are always equal. According to them, saving and investment are function of the

rate of interest.

Mathematically. S=f(r) ------------ (i)

I=(r) -------------- (ii)

Where; S=saving

R=rate of interest


27/40

ECONOMICS- POINT

27 | P a g e

.if we solve the above equations, then we will get the following result i.e.

SAVING(S) =INVESTMENT(I)

We may explain it with the help of the figure;

In the above figure, in ox-axis we measure the saving and investment and in oy-axis we measure

the rate of interest. The saving curve is the upward sloping; we know that higher the rate of

interest higher will be the saving, lower the rate of interest lower will be the saving. On the other

hand, if the rate of interest is high then the lower the investment and lower the rate of interest,higher the investment. But there is a point in which both saving and investment are intersect to

each other. That point is shown in the figure E, E, E are equilibrium point.

This view has been criticized by J.M.Keynes because the classical economists totally ignore the

income side. Again the view of classical theory is that there is full employment. This concept again

criticized by the Keynes. Because full employment is not a real concept.

Keynesian view:

Keynes explains the saving and investment equality in two ways;

Accounting equality:

Accounting equality means the equality in national income. He explains this concept in his book

general theory that saving and investment is necessary equal in amount for the community as a

whole, being different aspects of the something. It means saving and investment are equal in the

current period. We may explain this with the help of the equation;

St=Yt-Ct----------- (i)

It=Yt-Ct----------- (ii)

Yt-Ct is common in equations in both

St=ItWhere; S=Saving

Y=income


28/40

ECONOMICS- POINT

28 | P a g e

I=Investment

C=Consumption

T=Current period.

Keynes explains it in other way;

Yt=Ct+It---------- (i)

Yt=Ct+It---------- (ii)

Therefore from equation (i) and (ii);

Ct+It=St+Ct

But this equation has been criticized by modern economist. They says that there is no accounting

equality and Keynes failed to describe the actual dynamic process of adjustment between saving

and investment. For that reason prof.ohlin says the equality between saving and investment is

expost equality and not an exante one.

Functional equality:

Functional equality means saving and investment are always equal only at the equation level of

income we. In other words, saving and investment are not equal but they are also equation when

the saving more than the investment .income falls and when investment is more than saving, then

income arises.

We may explain it with the help of the table;

income saving Investment

100 -15 10

200 0 20 expansion

300 15 30

400 30 40

500 45 50

600 60 60 equilibrium

700 70 69

800 79 75 contraction

900 80 79

From the above table it shows that as the income increases, saving and investment will also

increases. Initially, saving increases more than the investment. But after one point, saving equal to


29/40

ECONOMICS- POINT

29 | P a g e

investment. That is equilibrium point. After equation point, saving and investment increases in a

diminishing return.

We may explain it with the help of the diagram;

In the above figure is the saving curve and II is the investment curve. Both are intersect to each

other at the point E. so E is the equality point. In OY investment is greater than saving and in OY,

saving is greater than investment. Therefore in OY, both saving and investment are equal to eachother.

Conclusion;

From the above discussion we can easily conclude that functional relation between saving and

national income on the one hand and investment and national income on the other hand. In this

manner saving schedule indicates various amounts of saving corresponding to different level of

national income and investment schedule represents the various amounts of investment

corresponding to different level of national income. So functional equality of saving and investment

enables us to understand the behaviors of the economy. Those behaviors are rate of interest,

bonds, securities etc. The importance of all this factors should not be ignored. There is a

interrelationship between Ex-ante and Ex-post approaches to the saving and investment theory.


30/40

ECONOMICS- POINT

30 | P a g e

Unit-4

Quest; Define multiplier and explain its working?

Or

Examine the meaning, working and importance of multiplier?

Ans; introduction;

The concept of multiplier occupies an important place in Keynesian theory of

income, output and employment. This concept was first time developed by F.A.Khan in the earlier

1930s but Keynes later further defined it. Khans multiplier is investment and employment

multiplier. On the other hand Keynes multiplier is known as investment or income multiplier

Keynesian multiplier is an important tool of income propagation and business cycle analysis.

According to Keynes, employment depends on the effective demand, which in turn depends upon

consumption and investment. Symbolically Y=C+I. he mentioned that consumption function is

stable in the short run and marginal propensity to consume is less than unit.

Therefore, all the increase in income does not go to increase consumption to the extent of

increment in income. With the result, a gap been created. That gap is technically known as

INVESTMENT. Keynes believed that the initial increment in investment increases the final income by

many times. To this relationship between an initial increase in investment and the final increase in

aggregate income is technically known as INVESTMENT MULTIPLIER / INCOME MULTIPLIER OR in

other words multiplier states the relationship between income and investment.

We may explain the multiplier in sym bolically;

K= Y / I

K =Multiplier

Y=Change in income

I=Change in investment

We may explain it in elaborate manner;

Y=C+I

Y=C+I

I=Y-C ---------- (1)

Now by definition we know that;


31/40

ECONOMICS- POINT

31 | P a g e

K=Y/I OR Y=K.I ---------- (2)

From the equation (2) we find that;

I=Y/K

Now substituting the equation (2) into (1), we get;

Y/K=Y-C --------------- (3)

Further dividing (3) by Y, we get;

Or K=1/1-C/Y=1/1-MPC=1/MPS

We may

C/Y (MPC) S/C (MPS) MULTIPLIER (K)=1/MPS

0 1 1

2

2/3 1/3 3

4

4/5 1/5 5

8/9 1/9 9

9/10 1/10 10

1 0 INFINITY

In the above it shows that the size of the multiplier varies directly with the marginal propensity

to consume and inversely with the marginal propensity to save. Since, MPC is always greater than 0

and less than 1. It means 0


32/40

ECONOMICS- POINT

32 | P a g e

y There are no time gaps in the multiplier process.y The new level of investment is maintained steadily for the completion of the multiplier process.y There are no changes in the prices.Working of the multiplier:

The multiplier works in two ways;

y Forward direction.y Reverse/backward direction.Now lets us discuss about following;

Forward working:

We know that multiplier is the mechanism through which income gets propagated, as a result of

original investment. The multiplier is said to be forward, when its investment increases that brings

out a multiple increase in income by increasing consumption.

We first take the sequenced analysis resource a motion picture of the process income propagation.

An increase in investment leads to increased productions which creates income and generate

consumption expenditure. This process continuous in dwindling (cumulative) series till no further

increase in income and expenditure is possible. According to Keynes, this is a log less instantaneous

process in a static framework.

It is better to explain forward working of multiplier with help of the concrete example.

Suppose that in an economy, marginal propensity to consume is , investment is raised by the

100crores. This will immediately lead to rise in production and income by rupee 100crores.

of this new income will be immediately spend on the consumption goods whish will lead to

increase in production and income by the same amount and so on.

We may explain it help of the following;

ROUND I (INCREMENT

IN INVESTMENT)

Y (INCREMENT

IN INCOME)

C=C.Y

C=0.5

S (Y-C)

(INCREMENT IN

SAVING)

0 100 100 50 50

1 50 25 25

2 25 12.5 12.5

3 12.5 6.25 6.25

4 6.25 3.12 2.12

5 0 0 0


33/40

ECONOMICS- POINT

33 | P a g e

In the above table it shows that an increment of rupee 100crores of investment in the primary

round leads to the same increase in income of these rupee 50 crores is saved and rupee 50crores

are spent on consumption which goes to increase income by the same amount in the second

round/flow. This dwindling process of income generation continues in the 2nd, 3rd, 4th and 5th

round until unless increment of income is 0, saving is 0 and consumption is zero.

K=Y/I

Y

I

If we put the value of above table, it gives the following result i.e.;

Y=K.I

200=2 100

Where K=2 (MPC=1/2)

I=100crore (I=Y/K=200/2)

This process of income propagation technically called forward working of the multiplier. We may

explain it with the help of the following figure;

In the side figure, in ox-axis we measure the consumption and investment. The c curve suggests

the MPC is equal to . C=I is the investment curve which intersect the equal distribution curve (45

angle curve) at point E. at that point OY is the income suppose if there is any further increase in

investment i.e. C+I+I, then that curve will intersect the equal distribution curve at E and the

income increases OY to OY. In fig A, Y is twice the distance between C+I and C+I+I.


34/40

ECONOMICS- POINT

34 | P a g e

In the fig B, if we take the MPS, then the result will be same by taking MPC. But it is very essential

to explain multiplier process by taking MPS. The curve S is the saving function with a slope of 0.5

to show MPS of . I is the old investment curve which cut S at point E. So E is the initial

equilibrium point and OY is the income level. Suppose, investment increases i.e. I+I, then the new

investment curve will intersect E with OY level of i9ncome.the level of income i.e. YY is exactly

double the increase in investment I.

BACKWARD OPERATION OF MULTIPLIER/REVERSE OPERATION:

Multiplier is a double edged weapon. It works in the backward direction as much as in the forward

direction. According to prof. Samuelsson, the multipliers a two edged sword. It will cut for you

against you. It will amplify new investment as we seen it will amplify downwards and decline

investment.

When the investment process cut down and MPC increases greater the value of multiplier and

greater the cumulative decline in income leads to the backward operation of the multiplier. We

may explain with the help of the figure;

In the above figure, SS is the saving curve. I is the investment curve. I curve intersect the saving

curve at the point E1 with OY1 level of income. When investment declines from I to I, the income

also declines from Y1 to Y2 and the new equilibrium will be E2Y2. So the income decreases by Y1Y2.

In this case decline of income is doubled, than decline in investment.

Leakages of the multiplier;

Leakages are the potential diversions from the income stream which tend to weaken the multiplier

effect of new investment. There are several factors which are responsible for the leakages of

multiplier. Those are;

Saving;Higher is saving, smaller the size of multiplier.

Strong liquidity preference;Stronger the liquidity pref erence, weaker will be the multiplier process.


35/40

ECONOMICS- POINT

35 | P a g e

Purchase of old stocks and securities;The size of the multiplier will fall with a fall in consumption expenditure, when people buy old

stocks and shares.

Debt cancellation;The multiplier process will be arrested when the debtor repay debts to the government.

Price inflation;Price inflation is another important leaking process in multiplier. When the price of the

commodity increases, then the real income of the consumer decreases, that will restrict the

consumption whish result the multiplier process.

New imports;If increase in income is spent on the purchase of imported goods, it acts as a leakage out of the

domestic income stream.

Undisturbed profit;Undisturbed profit with the companies tends to reduce the income and expenditure on

consumption goods whish weakens the multiplier process.

Taxation;Taxation policy is another important factor which weakens the multiplier process.

Public investment programs;No doubt the public investment progra ms helps in income and employment generation, but it

creates unhealthy atmosphere in private sector that will restrict the multiplier process.

Importance of the multiplier;

The concept of multiplier is one of the important contributions of Keynes to the i ncome and

employment theory.

It helps in the investment, trade cycle. Saving and investment equality. Formulation of economic policy. To achieve full employment. To understand the phenomena of inflation, deflation and deficit financing.Limitations;

No doubt the introduction of multiplier analysis in income theory is one of the Keynes path

breaking contributions in as much as it has not only enriched economic analysis but also profoundly


36/40

ECONOMICS- POINT

36 | P a g e

affected economic policy. But this concept is not the original one of the Keynes. So, the modern

economists criticized the concept of multiplier and its limitations in following grounds.

yIt is not a dynamic CONCEPT; Keynesian concept of multiplier is not a dynamic one. Because the relation between income and

consumption is not so simple.

y AVALAIBILITY OFTHE CONSUMER goods; The process of income generation is subject to the availability of consumer goods, and then the

multiplier will work well. But in real world, the availability of the consumer goods are lacking.

For that reason multiplier function also was limited.

y Simple assumptions;The assumption made by the multiplier is very simple. These assumptions say nothing new. So

the modern economists criticized it.

y Strange and vague concept;Prof. Hazlitt has criticized the concept of multiplier. According to him, he calls it as a strange

concept, as a myth and much ado about nothing.

y Tautological;Tautology implies unnecessarily repeating an established fact in different words without

purpose. It means we know that once the investment increases, that will increase the income.

So there is no need for explaining the concept of multiplier.

y Deficit financing;It gives undue importance to the policy of deficit financing. In the modern world deficit finance

play an important role. But Keynes ignored it.


37/40

ECONOMICS- POINT

37 | P a g e

Unit-4

Q.2. Do you think that Keynesian system applicable to under development!

Or

Is Keynesian theory applicable to underdeveloped country?

Ans. Introduction:-The Keynesian theory is not applicable to every social economic set up. It only applies to

advanced democratic capitalist economics. According to Schumpeter wrote practically Keynesian is a

seedling which cannot be transplanted in to foreign soil. It dies there and becomes poisonous before it dies.

But, left in English soil this seedling is a healthy thing and shade. All this applies to every bit of advice that

Keynes ever offered.

Before we study the applicability of Keynesian economics to underdeveloped countries it is essential to

analysis the assumptions of Keynesian economics than we examine whether those assumption are

applicability to underdeveloped countries or not.

Assumption Of Keynesian Theory:-

Keynesian theory is based on existence of cyclical unemployment. The Keynesian theory is a short run analysis. The Keynesian theory is based on closed economy. Keynesian assumes excess supply of labor. Lastly, utilization of resources concept is totally wrong.

The assumption on which the Keynesian theory is based is not applicable to the conditions prevailing in

under developed countries. Now it is a time to discuss the principle tools of the Keynesian theory to test

their validity to under developed countries. Those tools are:-

Effective Demand

Proportionate to Consume Saving Marginal efficiency of capital Rate of interest Multiplier


38/40

ECONOMICS- POINT

38 | P a g e

Effective Demand: - Unemployment is caused by the deficiency of effective demand. To solve this problem

Keynes suggested the stepping up of consumption and non-consumption expenditures. Unfortunately, in

underdeveloped country there is no in-voluntary unemployment but, there is a disguised unemployment. In

under developed country unemployment situation arises because of lake of economic structure. On the

other hand advanced country unemployment is caused due to lake of complimentary resources. So,

Keynesian theory of effective demand is not applicable to under developed country.

Proportionate to Consume :- Another important tool of Keynesian economics is the proportionate to

consume. Which explains the relation between consumption and income? It means when income increases

consumption also increases but, less than the increment in income. But, in underdeveloped countries these

relationship between not hold good. Because, people are very poor and when their income increases they

spend more on consumption goods because there tendency is to meet there unfulfilled wants. For that

reason marginal propensity to consume is very high as compare to advance country.

Saving:- According to Keynes saving as social vice. For it is excess of saving that leads to a decline in

aggregate demand. This idea is not applicable to underdeveloped countries because, saving is essential for

underdeveloped country. Capital formation is the key to economic development and capital formation is

possible through increased saving on the part of people. So, the Keynesian concept not applicable to

underdeveloped country. For under developed country saving is a virtue not vice.

Marginal Efficiency of Capital:- Another important determinant of the Keynesian economics is marginal

efficiency of capital. According to Keynes one of the important determinants of investment is the M.E. of

capital. There is an inverse relation between investment and M.E. of capital falls and when investment

increases M.E. of capital decreases. In underdeveloped country this type of relation is not applicable because

investment is low level. Same also M.E. of capital also low. This is due to lake of capital and other resources.

That is small size in market etc. All these factors keep investment at a low level.

Rate ofInterest :- The rate of interest is the second determinant of investment in the Keynesian system .The

rate of interest depend upon liquidity preference . According to Keynes lower the rate of interest higher will

be liquidity preference and higher the rate of interest lowers the liquidity preference. But, in under

developed country this concept is not applicable because of liquidity preference for transaction and

precautionary motive is very high then that for speculative motive there for liquidity preference a fails to

explain or influence the rate of interest.


39/40

ECONOMICS- POINT

39 | P a g e

The multiplier :- The multiplier means the relationship between an initial increases in investment and the

final increases in aggregate income. Keynes give the name of income multiplier or invest multiplier or

multiplier id the mechanism of income propagation, through it act in the reverse direction also. The concept

of multiplier is conceded as one of Keynes path breaking contribution because it helps in the study of public

sectors contribution and control of the trade cycle. According to Dr. Rao , Keynes never formulated the

economic problems of underdeveloped countries nor did he discuss the relevance to these countries for

either the objective or the policy that he purposed for the more developed countries. So, multiplier

concepts operate in an underdeveloped county like India. Mainly due to two reasons:-

i. Involuntary unemployment is not foundii. The supply of agriculture and non-agriculture output is inelastic.

Policy Measure:- The policy which had been adopted by Keynes not applicable to under developed

countries. Because, in underdeveloped countries there is always a rise in the price of the commodity same

also there is a unemployment situation which is conical in nature and there is lake of capital formation. Over

all this problem Keynes is not been able to succeed.

Conclusion:-

From the above discussion it shows that Keynesian theory is not been applicable to underdeveloped

countries because of the above reasons on this back ground proof. Das Gupta says the theory as a whole

may be in applicable but its tools taken separately are of great use in analyzing and solving the problems of

underdeveloped economics, and as those economics are becoming more developed, they afford greater

changes of Keynesian application.


40/40

macro unit 1

Documents