J.M. Keynes in his famous work “General theory of employment, interest and money” holds that in a capitalist economy it is not necessary that the equilibrium level of income is established at the level of full employment. But according to the classicists the economy has a tendency towards full employment.
Keynes contradicted the views of the classical economists. In the figure given below OY, represents the level of National income at which there is full employment in the economy. But pt OY, level of income the equilibrium level of income is not established but at OY level of income (OY < OY,) is the equilibrium level of income. The equilibrium at OY, level of income is known as under employment equilibrium.
The equilibrium level of national income will be established at -full employment level only when investment demand is sufficiently large to fill the saving gap between income and consumption corresponding to full employment level of income OY,. Corresponding to the full employment level of income OY, the savings of the community are SR.
If the equilibrium is to be established at OY, levels the investment demand must be equal to SR.’ But the prevailing investment demand is PQ which is less than SR. With SR level of investment and the ‘C’ curve as the propensity to consume, C+l curve will represent the level of aggregate demand. This (C+l) curve interests the aggregate supply curve OZ at point S and thus determines level of income equal to
There is no certainty of increase in the amount of investment to the extent of saving gap corresponding to the full employment level of income. Firstly people who save are not necessarily the investors. It is the general public who save but some few people undertake investment.
Secondly the factors determining savings and investment are not equal. People save to face the dangers in the future or for the marriage and education of their children. They save to have luxurious durable goods. But the level of investment depends on the Marginal efficiency of capital or expected profitability and the rate of interest which is assumed to be sticky in the short run.
Thus it is not certain that investment should be equal to the amount of savings by the people at full employment level. If profit expectation changes, the level of investment falls, the equilibrium level of income will also decline. If the investment increases above the (C+l). It will mean that the economy is spending and demanding more than it can produce. The net result will be the rise in a year is higher than SR the inflationary pressure will start. The national income will rise beyond OY, only in money terms but not in real terms.