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Unemployment refers to a situation when people do not have work despite the fact that they are actively searching for it. Economists have divided unemployment into various types in order to understand why it occurs as well as the actions that can be undertaken in order to reduce it. Basically, unemployment can be categorized into voluntary and involuntary unemployment (De Vroey 2002). Voluntary unemployment is characterized by people freely leaving their prior jobs and searching for new employment. On the other hand, involuntary unemployment is characterized by people being dismissed from their jobs and now searching for new ones. Involuntary unemployment also occurs when an individual is ready to work at the existing wage but he/she does not have work. Involuntary unemployment is different from voluntary one in the sense that people opt to refrain from work owing to the fact that the prevailing wage is lower than their reservation wage. Unsurprisingly, economists generally consider involuntary unemployment as a bigger problem when compared to voluntary unemployment owing to the fact that the latter is likely to relate to utility-maximizing household decisions (Eaton, Eaton & Allen 2009).
Economies having involuntary unemployment are characterized by excess labor at the prevailing wage. In addition, the basic supply and demand model at competitive equilibrium cannot be used in representing involuntary unemployment; it results from the fact that all workers falling below the prevailing wage in the labor supply curve are likely to opt not to work whereas those falling above the prevailing wage are likely to be employed (Eaton, Eaton & Allen 2009). With regard to the basic supply and demand model,involuntary workers are not part of the labor supply curve. A number of theories have been used to explain the likelihood of involuntary employment, which includes efficiency wages, staggered wage setting, disequilibrium theory, and implicit contract theory. This paper discusses how the concept of involuntary unemployment is supported by the principle of effective demand in Keynes’ general theory. In this context, the paper also outlines what constitutes unemployment equilibrium.
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The Keynesian Principle of Effective Demand and Its Support for Involuntary Unemployment
The principle of effective demand is crucial in Keynes’ general theory of employment, which proposes that the amount of effective demand that an economy has determines the volume of unemployment (Romer 2011). As a result, an inference that can be made from this proposition is that unemployment can be attributed to a shortage of the total demand, that is, the effective demand. Therefore, Keynes’ general theory of employment is analogous to the demand efficiency theory. Keynes used the phrase “effective demand” in its broadest sense to refer to the total demand of services and goods for both investment and consumption by the population in a particular community (Romer 2011). With respect to a money economy, therefore, the effective demand is visible in either expenditure flows or income spending. The income flow is determined by the expenditure flow owing to the fact that spending by one person translates into income for another person. In a real world scenario, the expenditure flow comprises both investment and consumption expenditure, which denotes the total demand for services and goods. In order for such a demand to be met, people have to be employed either in the production of capital goods (which constitutes the investment demand) or in the production of consumption goods (which constitutes the consumption demand). In such a case, there is an increase in employment only if there is growth in the total demand, which may be either in investment or consumption demand (Snowdon & Vane 2005). The basic principle is the presumption that an increase in income translates to growth in consumption albeit in a manner that is less proportionate. Therefore, the gap between consumption and income will widen; this implies that sustaining this expenditure flow requires the gap to be filled using suitable investment expenditure (Romer 2011). As a result, it is only possible to sustain employment and effective demand if investment demand rises together with an increase in the income levels. In such a case, a shortage of the effective demand is observed when the investment expenditure fails to bridge the gap between consumption and income. This is the primary factor that causes unemployment. An inference that can be made from this proposition is that promoting employment requires an increase in the effective demand, which can be attained by increasing investment. Overall, it can be summarized that the Keynesian principle of effective demand states that the amount of total labor employment depends on the equilibrium relationship between product demand and supply. There is no doubt that the product demand depends mainly on the prevailing and past income levels of the spenders (Snowdon & Vane 2005). Owing to the fact that a positive correlation exists between the total income and the total labor employment, a strong positive correlation ought to exist between the total labor employment and the total product demand.
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