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Wednesday, August 26, 2009

Keynesian's Theory of Employment

Wednesday, August 26, 2009 - 0 Comments

In his General Theory Keynes presented an explanation of the Great Depression of 1930’s and suggested measures for the solution. He also presented his own theory of income and employment. According to Keynes, in the short period, level of national income and so of employment is determined by aggregate demand and aggregate supply in the country. The equilibrium of national income occurs where aggregate demand is equal to aggregate supply. This equilibrium is also called effective demand point.

Effective demand represents that aggregate demand or total spending (consumption expenditure and investment expenditure) which matches with aggregate supply (national income at factor cost). In other words effective demand is the signi factor of the equilibrium between aggregate demand (C + I) and aggregate supply (C + S). This equilibrium position (effective demand) indicates that the entrepreneur neither have tendency to increase production. It implies that the national income and employment which correspond to the effective demand are equilibrium levels of national income and employment. Keynesian theory of income and employment emphasises that the equilibrium level of employment would not necessarily be full employment. It can be below or above the level of full employment.

The determinants of effective demand and so of equilibrium level of national income and employment are the aggregate demand and aggregate supply.

1. AGGREGATE DEMAND:

Aggregate demand refers to sum of expenditure, households, firms and the government is undertaking on consumption and investment in economy. The aggregate demand price is the amount of money which the entrepreneurs expect to receive as a result of the sale of output produce by the employment of certain number of workers. As increase in the level of employment lowers it the aggregate demand curve AD would be positively slopping signifying that as the level of employment increases the level of output also increases, thereby increasing of aggregate demand for goods. The aggregate demand thus depends directly on the level of real national income and indirectly on the level of employment.

2. AGGREGATE SUPPLY:

The aggregate supply refers to the flow of output produced by the employment of workers in an economy during a short period. 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 entrepreneur must receive to cover the costs of output produced by the employment of certain number of workers. The aggregate supply is denoted by (C + S) because a part of this is consumed (c) and other part is saved (S) in the form of inventories of unsold output. The aggregate supply curve (C + S) is positively slopped indicating that as the level of employment increases the level of output also increases, thereby increasing the aggregate supply. Thus aggregate supply (C + S) depends upon the level of employment through the economy’s aggregate production function.

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.

In above figure the aggregate demand curve (C + I) intersects the aggregate supply curve (C + S) at point E1 which is an effective demand point. At point E' the equilibrium of national income is OY1. Let us assume that in generating of OY1 level of income some of the workers willing to work have not been absorbed. It means that E1 (effective demand point) is an under employment equilibrium and OY1 is under employment level of income.

The unemployed workers can be absorbed if the level of output can be increased from OY1 to OY2 which we assume is the full employment level. We further assume that due to spending by government the aggregate demand curve (C + I + G) rises. As a result of this economy moves from lower equilibrium point E1 to higher equilibrium point E2. The OY is now the new equilibrium level of income along with full employment. Thus E2 denotes full employment equilibrium position of economy. Thus government spending can help to achieve the full employment.

Difference Between Social Accounting and Private Accounting and its Uses

following are certain similarities and difference between private accounting and social accounting.

1. Private accounting is done on the method of double entry book-keeping. That is each transaction is recorded twice in the books of the business an for instance a cash sale will be entered once in the appropriate ledger accounts as a credit to the good sold and it is again entered in the cash amount as a debit in respect of the cash received. In social accounting, however, cash transect on are not separately presented. On the other hand cash balances are recorded in the capital transaction account. This shows that social accounting also asrpts the double entry method but the second entries are not recorded in detail.

2. An other difference between private accounting and social accounting is that private accounts relate to the individual businessmen. Each transaction is thus recorded from one point of view only. On the contrary social accounts related to a connected and closed network of all businessmen. There are no loose ends. Each transaction is recorded from the point of view of the two transactors connected with it.

3. The third difference between private accounting and social accounting is that the accounts of private businessmen are usually presented in the form of a profit and loss account which shows income and its allocation. There is also set out a balance sheet which shows the stock of assets and liabilities at the end of accounting period. The profit and loss account of a private individual resembles in social account ting to what is called as the appropriation account. The only difference is that in private accounting, the profit often includes some elements of costs such as depreciation of plant and machinery and fees paid to the directors of company. On the other hand in social accounting these incomes are shown net. There is no counterpart at all of balance sheet in social accounting since there are insuperable difficulties in collecting the necessary information completely and on a uniform basis regarding assets and liabilities of all transactors in the economy.

Uses of Social Accounting

Uses of social accounting are given below:

(i) One purpose of the preparation of social accounting is to give the reader a clear picture of the economy as a whole. In social accounting we find a classified account of the various transactions entered into the various sectors of the economy. From these transactions, we can have a fairly clear view of the working of the entire economic system. These days we are not interested so much in the accounts of private businessmen, however big and prominent they may be. On the other hand we are interested in the health of economy and the way in which it functions. It is understood that a healthy economy is able to impart strength and health even to the economic affairs of private individual intelligent citizens are keen to know that how an economy is faring at particular moment or in a particular period of time. This is clearly reflected in social accounting.

(ii) We are all fairly familiar with the objectives placed before our Five Year Plans. They all relate to the economy as a whole. We want economic growth with stability or we want to build up a self reliant and self generating economy. How far we are able to achieve these objectives can be very well found out from the depreciation of various transactions and activities given in social accounting. Thus if we want to promote efficiency and stability of our economy preparation of social accounts is must.

(iii) Measurement of economic welfare is another purpose of the preparation of social accounts. We have mentioned above our Five Year Plans. At the end of each plan, we naturally like to known how far the masses have benefited from the plan. In other words we want to know o what extent economic welfare of the masses has been promoted. From social accounting and its study we can know at glance to what extent the masses are better off than at the time when planning started.

(iv) There is another important use which social accounting serves. From study of social accounting we are in position to find out how the different sectors of economy are inter-related to each other. We can for instance find out to what extent the industrial sector depends on the agricultural sector. We can also know to what extent the growth of our export sector is conditioned by our industrial and agricultural growth. To economists and persons engaged in economic planning. These inter-relationships are of very great use. In fact the information that social accounting furnishes about the mutual relationship of the various sectors of the economy is indispensable.

(v) Social accounting serves a very practical purpose for the statesman, the government administrator and the politician. It is on the basis of social accounts that intelligent and effective government policies in fiscal, monetary and other economic spheres can be formulated and executed.

Social Accounting in an Open Economy

An open economy is an economy having economic dealings with other countries of the world. Simple representation of an economy discussed in closed economy seems to be unrealistic when we think of what happens in the economic system actually. We find that in practice economic system are seldom self contained. On the other hand, they enter into extensive economic relationship with other economic system. To put it into simple language we can say that no country in the world is self sufficient. There may have been a time when various territorial units were ignorant of the existence of one another and led a self contained economic life. It is said that villages of our country were at one time self-sufficient economically i.e. they consumed what they produced and produced only for domestic consumption. Such a situation no longer exists. On other hand we find that there are extensive trading and capital transaction taking place between one country is not self sufficient. Thus we find that economic system of the world represented by individual countries is very closely interrelated. In social accounts are to be realistic we have to introduce this new element in social accounts which may be represented by rest of the world. Hence for an open economy we can classify the social accounts into (a) Production (b) Consumption (c) Rest of the world and (d) Accumulation. The rest of the world stands for the totality of other economies with which the economy in question is connected by virtue of economic relationship i.e. buying and selling, borrowing and lending etc.

In this diagram imports and exports of the country in question from and to the rest of the world have been shown. These are shown by flows connecting production with the rest of the world. In the view of the fact that the value of the exports and imports is seldom equal to each other, we show in the diagram an arrow towards the rest of the world from accumulation. This flow is called net lending abroad. This is a situation in respect of a country which has a favourable balance on current account which has a favourable balance on current account which it lends to abroad.

In the above diagram the flow into any given box sum up to the same total as the flows which go out of that box. The total has to be same, it can not be otherwise. We therefore get the following equations.

Y=C+S…………….(1)

S=I+L………………(2)

X=M+L…………….(3)

In the above equations Y stands for income (paid on payable to the factors of production) C is consumer’s expenditure on commodities, S is the saving and I is investments, the X stands for exprts M for imports and L for net amount lend. By substituting for L from equation 3 into 2 and then for s in from 2 into 1 we get the equation.

Y=C+I+X-M

This equation shows that income payments are equal to consumption expenditures plus capital expenditure on real assets. Plus the excess of the value of exports over the value of imports.

There is no doubt that this diagram is more realistic but is not sufficiently detailed as to give a complete picture of the economic system actually in operation. It does not contain provision for deprivation which is very necessary since buildings and machinery do not last for ever. Provision for deprivation is taken directly to accumulation to serve as source for funds meant for the replacement of real assets.

Secondly we have to take into account taxes, both direct and indirect levied by government and its subsidies given by it. We also to take not of the fact that the number of transactions between the economy in question and the rest of the world is much greater than described here.

Thus the actual situation to be represented by social accounts becomes very much complicated. If the social accounts are to be realistic the flow & called consumption expenditure going from consumption to production should include not only the consumption expenditures of the individuals and non-profit institution but also public consumption i.e. of public agencies. It may be more convenient to route these expenditures abroad through the domestic productive system which will therefore appear both as imports and as purchases from production. Similarly the flows of savings going from consumption to accumulation should include no only the savings of individuals, non profit institutions and business ferias but also savings by government agencies. In case the government has a deficit on current accounts showing negative saving the flow of saving by the private sector over the negative saving of public sector.

Social Accounting in a Closed Economy

A closed economy is one which is self-contained and self-sufficient so that it has no economic dealings with the outside world. In a closed economy the accounts may be prepared on a uniform basis and classified as (i) transactions relating to productive activity (ii) transaction relating to the use of gain from productive activity (iii) transactions relating to capital. By consolidating these accounts prepared for each firm, house hold, government agencies and every other transactor, we get three consolidated national accounts (a) Production (or operating) Account (b) Consumption (or appropriation) Account (c) Accumulation (or capital transaction) Account. Let us explain there three accounts.

In this account we include all productive activities being carried on in the entire economy. It is a consolidated production statement relating to all firms operating in the economy. These firms manufacture commodities meant for consumption and capital goods and equipment for generating accumulating wealth. The income obtained by these firms therefore comes through two channels viz partly by selling consumption goods and partly be selling capital equipments. The flow of this revenue is indicated by the direction of the arrows.

In these accounts purchases and sells by the firms from one another have obviously to be left out. They may be important for individual accounts but in the national or social accounts they cancel out.

In the above diagram, all proceeds of the sales of production are shown as being paid out as income to the factors of production i.e. to those who have taken part in the process of production. These payments take the form of wages to labour, salaries to the employees interest on capital, rent the land lord i.e. the owners of land and business premises and profit going to the entrepreneur. The incomes are shown in the diagram as flowing from production its consumption by an arrow.

The incomes received by the factors production may be either spent on consumption i.e. for the satisfaction of their immediate wants or they may be party saved. The income spent on commodities is shown by an arrow going towards production from consumption and the part which is saved is shown by the arrow going from consumption to accumulation. Transactions of the consumers among themselves paying cash to one another are ignored just as we ignored the buying and selling activities of the producers among themselves.

We have seen that whole of the sale proceeds of production go into consumption and consumption income is divided into spending and saving. It follows therefore that saving is equal to capital expenditure on real assets or investments. Thus we get following two equations

Y = C + S -------------(1)

S = I -------------------(2)

Here Y stands for income paid to the factors of production, C stands for consumers expenditure on commodities and services and S is saving (for income not consumed) I is investment (or capital expenditure on real assets) If we substitute for S from equation (2) into equation (1) we get the following equation.

Y = C + I ---------------(3)

There relationships pertain to simple closed economy which has no trading or financial relations with rest of the world.

Social Accounting and its Usefulness

The Social Accounting is a term which is applied to the description of the various types of economic activities that are taking place in the community in a certain institutional frame work. In Social Accounting we are concerned with statistical classification of the economic activity so that we are able to understand easily and clearly the operation on the economy as a whole. In the words of Stone and Murray “The term social accounts is used in a general sense to denote an organized arrangement of all transactions, actual or imputed in an economic system. In such a system distinctions are drawn between (i) Forums of economic activity, namely production, consumption and accumulation of wealth (ii) Sectors or institutional division of the economy and (iii) types of transactions, such as sales and purchases of goods and services, gifts, taxes and other current transfers etc.

Here is another version about the filed of social accounting. “The field of studies-summed up by the words “social accounting” embraces however not only the classification of economic activity but also the application of the information thus assembled to the investigation of the operation of the economic system. Social Accounting is thus concerned with the analytical as well as statistical elements of the study of national accounts.

In social accounting a transactor is supposed to keep a set of three accounts in which transactions are entered

(a) In the first account, incomes and outgoings relating to a productive activity of the transactor are brought together. The difference between the two indicates the profit or the gain.

b) The second account seeks to show how this profit and any other income that accrues to the transactor are allocated to different uses. The excess of income over rutlay is the measure of savings.

(c) The third account shows how this saving and any other capital funds are used to finance the capital. Expenditure or to give loans to other transactors. These accounts show the assets and liabilities of the person concerned at the beginning and at the end of whole, the transactors are numerous, they are grouped into sectors. In the sector, accounts of a same type are consolidated.

Social accounting or preparation of social accounts has assumed great importance in modern times. This is so because modern theory is being increasingly applied for the solution of economics is to be fruitful, knowledge of social accounts is absolutely essential. In the absence of a clear picture of the working of economy, an economist is seriously handicapped in giving practical advice to the government or to businessman. It is only with the help of social accounting that one can clearly trace the effects of changes in one section of the economy on the other section. Now we can briefly explain the main purposes of social accounting.

(i) One purpose of the preparation of social accounting is to give reader a clear picture of the whole economy. As in social accounting we find classified accounts of the various transactions entered into various sectors of the economy. From these transactions we can have fairly clear view of the working of the entire economic system.

(ii) We all are interested in the health, efficiency and stability of the economy since, a healthy and efficient economy results into health and efficiency of individual business. We all are familiar with the objectives placed before our Five-Year plans. They all relate to the economy as a whole. We want economic growth with stability or we want to build up self reliant and self-generating economy. How far we are able to achieve these objectives can be very well found out from the description of various transactions and activities given in social accounting. Thus if we want to promote efficiency and stability of our economy, preparation of social accounts is must.

(iii) Measurement of economic welfare is another purpose of preparation of social accounts. We have mentioned above our Five-Year Plans. At the end of each plan we naturally like to know how far the masses have benefited from the plan. In other words, we want to know to what extent economic welfare of masses has been promoted. From social accounting we can know at a glance to what extent the masses are better off at the time when planning started.

(iv) There is another important use which social accounting serves. From study of social accounts we are in position to find out how the different sectors of the economy are inter-related to each other. We can for instance find out to what extent the industrial sector depends on the agricultural sector and vice versa we can also know to what extent the growth of our export sector is conditioned by our industrial and agricultural growth to the economists and to persons engaged in economic planning these inter-relationships are of very great use.

(v) Social accounting serves a very practical purpose for statesman, the government administrator and the politician. It is on the basis of social accounting that intelligent and effective government policies in fiscal, monetary and other economic spheres can be formulated and executed. In the absence of social accounts, such policies can well be miss-leading and may result in economic disasters. The national resources are limited and it will be criminal to fritter them away. It is therefore very necessary that every care is taken in the formulation of national policies. Only social accounts can give us proper guidance in this connection.

What is National Income?

The term National Income has been defined by various economists According to Collin Clark “The National Income for any period consists of the money value of the goods and services becoming available for consumption during that period, reckoned at their current selling value, plus additions to capital reckoned at the prices actually paid for the new capital goods unless depreciation and obsolescence of existing capital goods and adding the net accretion of or deducting the net drawings upon stock, also reckoned at the current prices.”

In the words of Pigon “National Income is that part of the objective income of the community including of course income derived from absorbed which can be measured in money.”

We can say that National Income is the sum total of all the commodities and services produced by the residents of a country during a given period of time, conventionally one year. This national income is estimated by

(i) Product or output method (ii) Income method (iii) Expenditure method.

These methods are discussed in detail as under:

(i) The product or Output Method: This method approaches national income from the output side. According to this method, the economy is divided into different sectors such as agriculture, mining, manufacturing, small enterprises, commerce, transport, communication and other services. Then the gross product is found out by adding up net values of all the production that has taken place in these sectors during a given year.

In order to arrive at the net value of production of a given industry, the purchases of the producers of this industry form producers of other industries or sectors are deducted from the gross value of production of that industry. The aggregate or net values of production of _____ the industries and sectors of economy plus the net income from abroad will give us Gross National Product. By subtracting the total amount of depreciation from the figure of gross national product we get the net national product or national income. This method of estimating national income enables us to trace the origin of national income aggregate to the different sectors of the economy. Therefore this is called national income by industrial origin.

(ii) Income Method: This method approaches national income from the distribution side. In other words this method measures the national income after it has been distributed and appears as income earned or received by individuals of the country. Thus according to this method national income is obtained by summing up of the incomes all individuals in the country. Individuals earn income by contributing their own services and the services of their property such as land and capital to the national production. Therefore national income is calculated by adding up rent of land, wages and salaries of the employees, interest on capital, profits of entrepreneurs (including undistributed profits of joint stock companies) and income of self employed people.

This method of estimating national income has the great advantage of indicating the distribution of national income among different income groups such as landlords, capitalists, workers etc. Therefore this method is called national income by distributive shares.

(iii) Expenditure Method: This method approaches national income by adding up all expenditures made on good and services during a year. Income can be spent either on consumer goods or investment goods. Thus we can get national income by summing up all consumption expenditure and investment expenditure made by all individuals as well as government of a country during a year. Hence the gross national product is found by adding up

(a) What privale individuals spend on consumer goods and services? This is called personal consumption expenditure.

(b) What privale business spends on replacement, renewals and new investment? This is called gross domestic private investment.

(c) What the foreign countries spend on the goods and services of the national economy over and above what this economy spends on the output of the foreign countries i.e. exports minus imports.

(d) What the government spends on the purchase of goods and services i.e. government purchases we have explained above three alternative methods of estimating national income. The best way to arrive at national income will be to employ all these three methods so as to permit their cross checking ensuring greater accuracy and throwing light on details.

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