In 1936 Lord Keynes wrote a book entitled “General Theory of Employment, Interest and Money”. It was due to this book that he was conferred the title of Lord. In this book he directly opposed the postulates of the classical economists. The word ‘General’ in the title of this book carries specific meanings. It explains that the Keynesian theory deals with the level of employment in general, which keeps on changing and is never stable at any particular level. This is to contrast the, classical theory which is a special or specific theory of employment. Secondly, Keynes deals with the economy and its components in aggregate e.g. aggregate output, aggregate supply, aggregate demand, aggregate savings, aggregate investment, aggregate employment etc. This is to show that aggregates represent the general situation.

In his book Keynes not only dealt with the general level of employment but also extensively looked upon the problem of general unemployment and suggested measures for its solution. There are some assumption upon which Keynes based his theory of employment.

1) Employment level is determined in the short run.
2) Money prices of goods and services and rewards of the four factors of production remain constant.
3) The economy is assumed to be a closed economy.
4) There is to be no change in the pattern of income distribution.
5) Also there is to be change in the capital equipment and technological know-how.
6) Marginal propensity to consume remains stable.

With these assumptions, Keynes says that the level of employment in an economy depends upon the level of effective demand. If the level of effective demand goes up, the employment level also goes up and vice versa. Effective demand itself manifests the spending of income i.e. National Expenditure= National Income. Effective demand depends upon two factors i.e.

Aggregate supply
Aggregate supply of output is the total national product produced and marketed in the final form in one year. It amounts to the same things as Real National Income or the money value of final goods and services produced in a country in a year at constant factor cost. The entrepreneurs employ a certain level of labourers to produce the goods and services with an obvious view to maximize their profit. They eventually increase the number of labourers employed in the production process and as a result output level also, increases. Hence, their expected sale proceeds (total revenues) also increase due to which they are able to maintain a high level of employment. Thus, the fact is that expected sale proceeds determine the exact level of employment.

Aggregate demand
This means aggregate demand of all goods and services produced in their final form, in one year, or alternatively, in terms of money it is known as the Total National expenditure incurred on the final goods and services produced in a country. The Keynesian aggregate demand theory represents the expected sale proceeds of the entrepreneurs which they can expect to obtain on the sale of the national product produced by a certain level of employment. Thus, the aggregate demand is represented by the same two variables i.e. expected sale proceeds and the level of employment.

In contrast to Keynes, the classical economists believe in full employment and that there is no such thing as, unemployment and over production; whereas Keynes pointed out that the theory is not in accordance with the real life situation. The real situation is that level of income and employment depends upon effective demand i.e. if effective demand goes up there will be increase in the level of employment and vice versa. The implications of Keynes’ approach are as follows:

Unemployment is the greatest phenomenon in an economy now-a-days, especially in the underdeveloped countries, the reason for this to occur is that there is very low level of investment in these countries, therefore, income generated is equally low and hence resources of the country remain idle and unemployed.

However, unemployment not only occurs in underdeveloped countries, developed countries are also facing the same problem although to a lesser extent. This is because developed countries have got to maintain, if not to increase, their already high level of investment. This is not always possible and as a result unemployment to a little extent takes place.

In order to over come the problem of unemployment, particularly in the third world countries, consumption level should be cut down and in turn the level saving and investment be raised to increase the level of income and employment. Hence, full employment can be achieved in these countries with the passage of time. Whereas in case of unemployment in the developed countries, Keynes suggested the Government has to maintain the investment level so that it does not fall down from the level of full employment. Thus, Keynes points out that the Government plays a vital role in achieving this target in contrast to the classical economists who are against Government intervention. Hence, third world countries have to ensure that level of investment is always increasing have to ensure that level of investment is always increasing so that unemployment problem is eliminated; whereas developed countries have to, struggle for maintaining the required level of investment at full employment and not to all to fall so as to avoid the problem of unemployment. Keynes method of over coming unemployment is generally practiced throughout the world today which proves that Keynes theory has great practical relevance to the real life situation.

Keynes has suggested the vital role that a Government can play in stabilizing the economy; something that was never pointed out before. According to Keynes’s theory, if the point of Effective Demand is below the full employment level it will result in a deflationary gap. In this case, the role of the Government is to increase investment in the public enterprises without leaving an adverse effect on the growth of investment in the private sector so as to push the economy to fully employment level. An opposite role is suggested for the Government in the case of an inflationary gap.

Keynes says that mild inflation will take place when the point of effective demand is raised through the role of Government to increase the level of investment in the public sector. This is a great reality. Mild inflation takes place due to the factors given below.

The labourers employed to goods and services are non-homogeneous due to which a less efficient labourer producers less than the efficient labourer but still receives the same wage as that of the efficient one. As a result the cost of production goes up and hence the general price level in the economy rises.

Similarly, inelastic supply of certain raw materials will raise the general price level because with the increase in its price the cost of production goes up. Likewise increasing the wage rate through trade unionism without a corresponding increase in the production level also leads to mild inflation. The shortage of agricultural goods in the face of an ever rising demand for them also contributes to the rise in the general price level of commodities in the country.

According to Keynes, this type of inflation should be allowed in the economy of a country as it induces economic growth. This type of inflation we see in many third world countries in their process of growth.

Keynes says that a laissez-faire economy, if not controlled and regulated, will have a natural tendency towards economic depression. The argument that he gives is that income and employment level depends upon effective demand which mainly depends on investment. Investment in turn depend mainly upon marginal efficiency of capital (MEC-to be discussed later) which always shows a secular decline with the passage of time. When MEC falls, investment falls and hence income and employment also fall. This tendency is known as economic depression.

Keynes did a great service in identifying the tendency of depression in a laissez-faire economy.

Keynes suggested the role of fiscal policy in overcoming economic depression. This gives us the role of government in raising the level of investment in the phase of depression as the private sector will not be willing to do so. Moreover, Keynes believes that progressive taxes are automatic stabilizers of the economy and help in overcoming economic depression.

Keynes suggests a deficit budget in case of economic depression. That is why he recommends deficit financing to promote the level of income and employment in economic depression.