Theories of Employment and Income – Class 12 Text Book Solutions

PART A Multiple choice questions

1. Every able bodied person who is willing to work at the prevailing wage rate is employed called as ……….

(a) Full employment

(b) Under employment

(c) Unemployment

(d) Employment opportunity

2. Structural unemployment is a feature in a ………..

(a) Static society

(b) Socialist society

(c) Dynamic society

(d) Mixed economy

3. In disguised unemployment, the marginal productivity of labour is …..

(a) Zero

(b) One

(c) Two

(d) Positive

4. The main concention of the Classical Economic Theory is ……..

(a) Under employment

(b) Economy is always in the state of equilibrium

(c) Demand creates its supply

(d) Imperfect competition

5. J.B. Say is a …………………….

(a) Neo Classical Economist

(b) Classical Economist

(c) Modern Economist

(d) New Economist

6. According to Keynes, which type of unemployment prevails in capitalist economy ?

(a) Full employment

(b) Voluntary unemployment

(c) Involuntary unemployment

(d) Under employment

7. The core of the classical theory of employment is …………

(a) Law of Diminishing Return

(b) Law of Demand

(c) Law of Markets

(d) Law of Consumption

8. Keynes attributes unemployment to …………..

(a) A lack of effective supply

(b) A lock of effective demand

(c) A lack of both

(d) None of the above

9. ………. Flexibility brings equality between saving and investment.

(a) Demand

(b) Supply

(c) Capital

d) Interest

10. …………… theory is a turning point in the development of modern economic theory.

(a) Keynes’

(b) Say’s

(c) Classical

(d) Employment

11. The basic concept used in Keynes Theory of Employment and Income is…………….

(a) Aggregate demand

(b)Aggregate supply

(c) Effective demand

(d) Marginal Propensity Consume

12. The component of aggregate demand is ………….

(a) Personal demand

(b) Government expenditure

(c) Only export

(d) Only import

13. Aggregate supply is equal to ………….

(a) C + I + G

(b) C + S + G + (x-m)

(c) C + S + T + (x-m)

(d) C + S + T + Rf

14. Keynes theory pursues to replace laissez faire by …………

(a) No government intervention

(b) Maximum intervention

(c) State intervention in certain situation

(d) Private sector intervention

15. In Keynes theory of employment and income, ………….. is the basic cause of economic depression.

(a) Less production

(b) More demand

(c) Inelastic supply

(d) Less aggregate demand in relation to productive capacity.

16. Classical theory advocates ……

(a) Balanced budget

(b) Unbalanced budget

(c) Surplus budget

(d) Deficit budget

17. Keynes theory emphasized on …… equilibrium.

(a) Very short run

(b) Short run

(c) Very long run

(d) Long run

18. According to classical theory, rate of interest is a reward for ……

(a) Investment

(b) Demand

(c) Capital

(d) Saving

19. In Keynes theory , the demand for and supply of money are determined by ….

(a) Rate of interest

(b) Effective demand

(c) Aggregate demand

(d) Aggregate supply

20. Say’s law stressed the operation of …………. in the economy.

(a) Induced price mechanism

(b) Automatic price mechanism

(c) Induced demand

(d) Induced investment

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Part – B Answer the following questions in one or two sentences

21. Define full employment.

Answer: Full employment refers to a situation in which every able bodied person who is willing to work at the prevailing wage rate, is employed. Lerner defines full employment as “that level of employment at which any further increase in spending would result in an inflationary spiral of wages and prices”.

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22. What is the main feature of rural unemployment ?

Answer: The major feature of rural unemployment is the existence of unemployment in the form of disguised unemployment and seasonal unemployment.

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23. Give short note on frictional unemployment.

Answer: Frictional unemployment arises due to imbalance between supply of labour and demand for labour. This is because of immobility of labour, lack of necessary skills, break down of machinery, shortage of raw materials etc. The persons who lose jobs and in search of jobs are also included under frictional unemployment.

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24. Give reasons for labour retrenchment at present situation.

Answer: Modern technology being capital intensive requires less labourers and contributes to technological unemployment. Now a days, invention and innovations lead to the adoption of new techniques there by the existing workers are retrenched. Labour saving devices are responsible for technological unemployment.

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25. List out the assumptions of Say’s law.

Note: You can answer any 3 of the below points.

Answer: The Say’s Law of market is based on the following assumptions:

1. No single buyer or seller of commodity or an input can affect price.
2. Full employment.
3. People are motivated by self interest and it determines economic decisions.
4. The laissez faire policy is essential for an automatic and self adjusting process of full employment equilibrium. Market forces determine everything.
5. There will be a perfect competition in labour and product market.
6. There is wage-price flexibility.
7. Money acts only as a medium of exchange.
8. Long – run analysis.
9. There is no possibility for over production or unemployment.
10. Unutilized resources used until reaches full employment.
11. No Government intervention. Automatic Price adjustment mechanism operated.
12. Interest rate flexibility leads to saving.

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26. What is effective demand ?

Answer: Effective demand denotes money actually spent by the people on products of industry. The money which entrepreneurs receive is paid in the form of rent, wages, interest and profit. Therefore effective demand equals national income.

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27. What are the components of aggregate supply ?

Answer: Aggregate supply has the following four components:

1. Aggregate consumption expenditure (C)
2. Aggregate private savings (S)
3. Net tax payments (T) and
4. Personal transfer payments to foreigners (eg. Donations to international relief efforts)

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PART – C Answer the following questions in a paragraph.

28. Write the following in short
(i) Seasonal unemployment
(ii) Frictional unemployment
(iii) Educated unemployment

Answer:

(i) Seasonal unemployment: This type of unemployment occurs during certain seasons of the year. In agriculture and agro based industries like sugar,production activities are carried out only in some seasons. These industries offer employment only during that season in a year. Therefore people may remain unemployed during the off season. Seasonal unemployment happens from demand side also; for example ice cream industry, holiday resorts etc.

(ii) Frictional unemployment: Frictional unemployment arises due to imbalance between supply of labour and demand for labour. This is because of immobility of labour, lack of necessary skills, break down of machinery, shortage of raw materials etc. The persons who lose jobs and in search of jobs are also included under frictional unemployment.

(iii) Educated unemployment: Sometimes educated people are underemployed or unemployed when qualification does not match the job. Faulty education system, lack of employable skills, mass student turnout and preference for white collar jobs are highly responsible for educated unemployment in India.

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29. According to classical theory of employment, how wage reduction solves the
problem of unemployment. Diagramatically explain.

Answer: Classical economists assumed that the economy operates at the level of full employment without inflation in the long period. They also assumed that wages and prices of goods were flexible and the competitive market existed in the economy (laissez-faire economy).

When money wages are reduced, they lead to reduction in cost of production and consequently to the lower prices of products. When prices fall, demand for products will increase and sales will be pushed up. Increased sales will necessitate the employment of more labour and ultimately full employment will be attained.

Prof. Pigou illustrated this using the equation: N = q. Y/W where N = number of workers; q= fraction of income earned as wages and salaries; Y = full employment level of national income; W= wage rate. This can be explained with the following figure.

In the above diagram, S= supply curve of labour; D = demand curve of labour; E= point of full employment.

In diagram B, when the wage is reduced to the level of W/P, then unemployment disappears and attains full employment.

MPL = Marginal product of labour curve. It slopes downward as more labour is employed.
The full employment level is reached when the wage rate falls from W/P1 to W/P level.

When there is a reduction in wages, the real wage is also reduced to the same extent which reduces unemployment and ultimately brings full employment.

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30. Explain Keynes theory.

Answer:

The theory of Keynes was against the belief of classical economists that the market forces in capitalist economy adjust themselves to attain equilibrium. Keynes not only criticized classical economists but also advocated his own theory of employment.
Keynes’s theory was a general theory as it tried to explain all types of situations, i.e. not only equilibrium level of employment but also the concept of full employment as well as the possibility of underemployment.
Keynes’s theory of employment was based on the view of the short run. According to him, the factors of production such as capital goods, supply of labour, technology and efficiency of labour remain unchanged while determining the level of employment.

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31. What do you mean by aggregate demand ? Mention its components.

Answer: In the Keynesian model, output is determined mainly by aggregate demand. The aggregate demand is the amount of money which entrepreneurs expect to get by selling the output produced by the number of labourers employed. Therefore, it is the expected income or revenue from the sale of output at different levels of employment. Aggregate demand has the following four components:

• Consumption demand
• Investment demand
• Government expenditure and
• Net Export ( export – import )
  

The desired or planned demand is the amount that households, firms, the governments and the foreign purchasers would like to spend on domestic output. It is the sum total of desired private consumption expenditure, desired investment expenditure, desired government spending and desired net exports. Thus, the desired spending is called aggregate demand, and can be expressed as: AD = C + I + G + (X – M)

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32. Explain about aggregate supply with the help of diagram.

Answer: Aggregate supply function is an increasing function of the level of employment. Aggregate supply refers to the value of total output of goods and services produced in an economy in a year. Aggregate Supply = C + S + T + Rf = Aggregate income generated in the economy.
The following figure shows the shape of the two aggregate supply curves drawn for the assumption of fixed money wages and variable wages.

Z curve is linear where money wages remains fixed; Z1 curve is non – linear since wage rate increases with employment.

When full employment level of Nf is reached it is impossible to increase output by employing more men. So aggregate supply curve becomes inelastic. The slope of the aggregate supply
curve depends on the relation between employment and productivity. The capital stock is often fixed and hence the law of diminishing marginal returns takes place as more workers are employed. Based upon this relation, the aggregate supply curve can be expected to slope upwards.

In reality the aggregate supply curve will be like Z1. Therefore, the aggregate supply depends on the relationship between price and wages. If prices are high and wages low, the producers will try to employ labourers. If prices are low and wages high, investment will be curtailed, output will fall and there will be a reduction in the productive capacity. Thus aggregate supply is an important factor in determining the level of economic activity.

33. Write any five differences between classism and Keynesianism.

Answer:

Keynesianism	Classicism
Short-run equilibrium	Long-run equilibrium
Saving is a vice	Saving is a social virtue.
The function of money is a medium of exchange on the one side and a store of value on the other side.	The function of money is to act as a medium of exchange
Macro approach to national problems	Micro foundation to macro problems
State intervention is advocated.	Champions of Laissez-fair policy

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PART – D Answer the following questions in about page.

34. Describe the types of unemployment.

Answer: The following are the types of unemployment.

1. Cyclical Unemployment
   This unemployment exists during the downturn phase of trade cycle in the economy. In a business cycle during the period of recession and depression, income and output fall leading to widespread unemployment. It is caused by deficiency of effective demand. Cyclical unemployment can be cured by public investment or expansionary monetary policy.
2. Seasonal Unemployment
   This type of unemployment occurs during certain seasons of the year. In agriculture and agro based industries like sugar, production activities are carried out only in some seasons. These industries offer employment only during that season in a year. Therefore people may remain unemployed during the off season. Seasonal unemployment happens from demand side also; for example ice cream industry, holiday resorts etc.
3. Frictional Unemployment
   Frictional unemployment arises due to imbalance between supply of labour and demand for labour. This is because of immobility of labour, lack of necessary skills, break down of machinery, shortage of raw materials etc. The persons who lose jobs and in search of jobs are also included under frictional unemployment.
4. Educated Unemployment
   Sometimes educated people are underemployed or unemployed when qualification does not match the job. Faulty education system, lack of employable skills, mass student turnout and preference for white collar jobs are highly responsible for educated unemployment in India.
5. Technical Unemployment
   Modern technology being capital intensive requires less labourers and contributes to technological unemployment. Now a days, invention and innovations lead to the adoption of new techniques there by the existing workers are retrenched. Labour saving devices are responsible for technological unemployment.
6. Structural Unemployment
   Structural unemployment is due to drastic change in the structure of the society. Lack of demand for the product or shift in demand to other products cause this type of unemployment. For example rise in demand for mobile phones has adversely affected the demand for cameras, tape recorders etc. So this kind of unemployment results from massive and deep rooted changes in economic structure.
7. Disguised Unemployment
   Disguised unemployment occurs when more people are there than what is actually required. Even if some workers are withdrawn, production does not suffer. This type of unemployment is found in agriculture. A person is said to be disguisedly by unemployed if his contribution to output is less than what he can produce by working for normal hours per day. In this situation, marginal productivity of labour is zero or less or negative.

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35. Critically explain Say’s law of market.

Answer: Say’s law of markets is the core of the classical theory of employment.
According to Say, “When goods are produced by firms in the economy, they pay reward to the factors of production. The households after receiving rewards of the factors of production spend the amount on the purchase of goods and services produced by them. Therefore, each product produced in the economy creates demand equal to its value in the market.

Assumptions of Say’s Law:

The Say’s Law of market is based on the following assumptions:

1. No single buyer or seller of commodity or an input can affect price.
2. Full employment.
3. People are motivated by self interest and it determines economic decisions.
4. The laissez faire policy is essential for an automatic and self adjusting process of full employment equilibrium. Market forces determine everything.
5. There will be a perfect competition in labour and product market.
6. There is wage-price flexibility.
7. Money acts only as a medium of exchange.
8. Long – run analysis.
9. There is no possibility for over production or unemployment.
10. Unutilized resources used until reaches full employment.
11. No Government intervention. Automatic Price adjustment mechanism operated.
12. Interest rate flexibility leads to saving.

Implications of Say’s law

The implications of Say’s law are as follows:

1. There is no possibility for over production or unemployment.
2. If there exist unutilized resources in the economy, it is profitable to employ them up to the point of full employment. This is true under the condition that factors are willing to
   accept rewards on a par with their productivity.
3. As automatic price mechanism operates in the economy, there is no need for government intervention.
4. Interest flexibility brings about equality between saving and investment.
5. Money performs only the medium of exchange function in the economy, as people will not hold idle money.

Criticisms of Say’s Law

The following are the criticisms against Say’s law:

1. According to Keynes, supply does not create its demand. It is not applicable where demand does not increase as much as production increases.
2. Automatic adjustment process will not remove unemployment. Unemployment can be removed by increase in the rate of investment.
3. Money is not neutral. Individuals hold money for unforeseen contingencies while businessmen keep cash reserve for future activities.
4. Say’s law is based on the proposition that supply creates its own demand and there is no over production. Keynes said that over production is possible.
5. Keynes regards full employment as a special case because there is under – employment in capitalist economies.
6. The need for state intervention arises in the case of general over production and mass unemployment.

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36. Narrate the equilibrium between ADF and ASF with diagram.

Answer: Under the Keynes theory of employment, a simple two sector economy consisting of the household sector and the business sector is taken to understand the equilibrium between ADF and ASF. All the decisions concerning consumption expenditure are taken by the individual households, while the business firms take decisions concerning investment. It is also assumed that consumption function is linear and planned investment is autonomous.

There are two approaches to determination of the equilibrium level of income in Keynesian theory. These are :

• Aggregate demand – Aggregate supply approach
• Saving – Investment approach

Out of these two, aggregate demand and aggregate supply approach is alone explained to understand the determination of equilibrium level of income and employment.

In the figure, the aggregate demand and aggregate supply reach equilibrium at point E. The employment level is N₀ at that point.
At ON1 employment, the aggregate supply is N1 R1. But they are able to produce M1 N1. The expected level of profit is M1 R1. To attain this level of profit, entrepreneurs will employ more labourers. The tendency to employ more labour will stop once they reach point E.
At all levels of employment beyond, ON₀, the aggregate demand curve is below the aggregate supply curve indicating loss to the producers. Hence they will never employ more than ON₀ labour. Thus effective demand concept becomes a crucial point in determining the equilibrium level of output in the capitalist economy or a free market economy in the Keynesian system.
It is important to note that the equilibrium level of employment need not be the full employment level (N1). The difference between N₀ – Nf is the level of unemployment. Thus the concept of effective demand becomes significant in explaining the under employment equilibrium.

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37. Explain the differences between classical theory and Keynes theory.

Answer:

Keynesianism	Classicism
Short-run equilibrium	Long-run equilibrium
Saving is a vice	Saving is a social virtue.
The function of money is a medium of exchange on the one side and a store of value on the other side.	The function of money is to act as a medium of exchange.
Macro approach to national problems.	Micro foundation to macro problems.
State intervention is advocated.	Champions of Laissez-fair policy
Applicable to all situations – full employment and less than full employment.	Applicable only to the full employment situation.
Capitalism has inherent contradictions.	Capitalism is well and good.
Budgeting should be adjusted to the requirements of economy.	Balanced budget
The equality between saving and investment is advanced through changes in income.	The equality between saving and investment is achieved through changes of rate of interest.
Rate of interest is determined by the demand for and supply of money.	Rate of interest is determined by saving and investment.
Rate of interest is a flow.	Rate of interest is a stock.
Demand creates its own supply.	Supply creates its own demand.
Rate of interest is a reward for parting with liquidity.	Rate of interest is a reward for saving.