Aggregate supply, aggregate demand and level of employment, Macroeconomics

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As is the case with the supply and demand function for a single business firm determining the equilibrium price and output for its product, the aggregate supply and aggregate demand functions determine the equilibrium price level and output of an economy. According to this level of output, there is some employment which is given by the production function (i.e. a functional relationship between inputs and outputs) for that corresponding level of output. J M Keynes showed that this level of employment may fall significantly from the desirable level of employment. In other words, at the current market wage, the number of workers seeking gainful employment may exceed the number of workers actually absorbed or employed in the economy. Even then, this situation of less than full employment can be an equilibrium situation, which is called a less-than-full employment equilibrium - a normal phenomena in real life. Keynes says that in a free enterprise capitalist economy laissez-faire less-than-full employment is possible. On the contrary classical macro analysis with its underlying assumptions i.e. wage, price flexibility negated any possibility of underemployment situation in the economy. However the happenings of 1930s Great Depression and the recessionary conditions prevailing in industrialized countries since 1970 proved fatal to the orthodox thinking and forced governments to resort to fiscal measures as advocated by Keynes. A detailed analysis of this will be explored as we proceed.

 


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