Keynesian Theory of Inflation and Unemployment - Essay Example

Inflation, on the other hand, referrers increase in prices of products and services in any given economy, with a particular period duration. Essentially, when prices are high, amount of goods and services, which can be, bought using a particular amount of money becomes fewer (Burda & Wyplosz 1997). Disequilibrium positions of inflation Keynes disagrees with the economists of the classical argument. According to the argument by Keynes, market systems do not lead to automatic full-employment equilibrium (Warburton 1966).

However, the economic systems could attain equilibrium at any range of unemployment. This implied that the interventionists’ policies would not apply. Keynesian argument can be represented in a circular flow of revenue (Warburton 1966). Extra aggregate demand within the economic system forces firms to absorb more employees. According to Keynes, markets are bound to exhibit disequilibrium of various forms (positions) of inflation, which have been pointed in the Keynesian theory of inflation. . Similarly, aggregate supply can be indicated by Y = C + S because the market value of the total p[roduction of one year is called national income may be divided into consumption and saving.

In this way, national income will be determined at the point where following conditions will be fulfilled; aggregate demand = aggregate supply; total expenditure = total income; C + I = C + S; I = S. This can be explained by the help of the following diagram: In the above diagram, along X-axis we have measured national income and employment level and along Y-axis consumption and investment. C curve is consumption curve which moves from left to right upwards. The assumption is that investment remains the same at all levels of income, so C + I curve will remain parallel to C.

C + I curve indicates aggregate demand or the total expenditure at different levels of income. The income will be in equilibrium at the point where C intersects Y. in other words, aggregate demand is equal to aggregate supply or total expenditure is equal to total income when income is OM. From the point where Y and M intersect, to M, gives the effective demand since at this point, aggregate supply is equal to aggregate demand. If income is higher than OM, aggregate supply will be greater than aggregate demand and there will be overproduction.

The profits of the producers will fall and they will produce less in the next year, so income will decrease. Similarly, if income is lower than OM, aggregate demand will be greater than aggregate supply and it will be profitable to produce more and more and as a result of this, income will increase. In this way, income will be determined at OM and this is the