Macroeconomic Equilibrium and Employment
I now turn to a perennial question in macroeconomics since the time the General Theory was published: Can an economy be in equilibrium at less than full employment? Keynes’s answer in the General Theory was a clear yes. His reasoning (and mechanism) was that aggregate output and income are determined by the Principle of Effective Demand. Aggregate expenditure (and therefore income) is equal to the sum of consumption and investment expenditures, consumption (and therefore saving) is primarily determined by the level of income, investment is determined by the interest rate, and the interest rate is determined by Liquidity Preference. Savings and investment are brought into equilibrium through adjustments in the level of income, rather than through adjustments in the rate of interest. The resulting equilibrium level of output determines the level of employment, and there is no necessity for this to be at the full-employment level. Full employment could be foreclosed, for Keynes, either because of the ‘liquidity trap’ or because of a depressed marginal efficiency of capital.
KeywordsLabor Market Interest Rate Demand Function Real Wage Full Employment
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