Keynesian Theory of Employment

Last Updated On -05 Aug 2025

John Maynard Keynes is a name that resonates in modern economics, and for good reason. His theories opposed classical economics and changed the perception of the economy, employment, and the role of the government in the economy. The Keynesian Theory of Employment, formulated during the Great Depression, is still a critical aspect of macroeconomic policy.

What is the Keynesian Theory of Employment?

Keynesian Theory of Employment was put forward by John Maynard Keynes in 1936 through the book The General Theory of Employment, Interest and Money. It postulates that employment levels are a result of aggregate demand, and therefore, employment wouldn’t be the sole determining factor.

To put it simply, Keynes believed that unemployment was not a result of the economy being sluggish and therefore not needing workers. Furthermore, boosting demand through government spending, investment, and consumption is the best route to achieving full employment, and government spending should be prioritized in case of a recession.

Core Assumptions of the Keynesian Theory

Short-run is more important than long-run – Keynes famously said, "In the long run, we are all dead."
Classic economics still believes that money is neutral. Keynes believed the opposite to be true, making money valuable in the short run.
Wages and prices are ‘sticky’ – do not adjust rapidly in response to clear the market.
Employment is determined by aggregate demand – employment is not a result of only supply-side forces.
Governments need to step in the most during economic downturns.

The Employment Function in Keynesian Theory

According to Keynes, the level of employment in an economy is determined by effective demand, the demand that creates output and employment.

Two Schedules in the Keynesian Theory:

Aggregate Demand Function (ADF): Represents projected revenue for varying levels of employment.
Aggregate Supply Function (ASF): Represents the minimum revenue required to justify varying levels of employment.

The point of effective demand, which determines the equilibrium level of employment, is the intersection of these two curves.

Key Types of Unemployment in Keynesian Theory

The Keynesian Theory of Employment is a very useful approach to studying unemployment and economic cycles and developing relevant policies. It enlightens us that markets do not always self-correct, and in some situations, only active intervention will restore stability and full employment. In today’s dynamic global economy, Keynes’s insights continue to shape macroeconomic policies across the world.

Involuntary Unemployment: Job seekers willing to pay the prevailing wage but cannot find work.
Cyclical Unemployment: Results from a decrease in aggregate demand.
Demand Deficiency Unemployment: Acts as a direct outcome of insufficient effective demand.

Role of Government in the Keynesian Model

In contrast to classical economists who believed in laissez-faire, Keynes strongly advocated for:
Deficit spending during downturns.
Public works programs create jobs.
Tax cuts or subsidies to prompt increased consumption.
Monetary policies to lowering interest rates and stimulating investment.

Example To Understand Keynesian Employment

Consider a country in recession. If businesses are not investing and spending is not occurring, unemployment is bound to rise.

According to Keynesian economics, the role of the government includes the following interventions:

“C” increases as tax cuts are placed to increase spending.
“G” increases with the construction of new infrastructure, schools, bridges, and roads.
“I” increases with the promotion of investment by industries.

As a result, all of the above improve the aggregate demand of the economy, which further improves production and employment opportunities.

The importance of Keynesian economics today:

During the 2008 financial crisis, government stimulus spending was introduced in the US and abroad.
During the COVID-19 Pandemic, there was public spending to save businesses and jobs.

There have been further changes and challenges proposed to Keynesian economics, with the rise of New Keynesian and Monetarist views; however, the need for Keynesian economics to navigate economic cycles remains one of the most used staples in the economy.

Did you know?

With the influence of Keynesian economics, John Maynard Keynes was a member of the British delegation to the Bretton Woods Conference (1944), which later established the IMF and World Bank.

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Frequently Asked Questions (FAQs)

Which one is more preferred, the classical or the Keynesian way of explaining employment, and why?

In securing employment, the classical view is that since there is wage flexibility, there is a natural adjustment. The Keynesian approach, however, relies on aggregate demand and a likelihood of wages being ‘sticky’.