Question

Explain the concept of underemployment equilibrium with the help of a diagram.

Answer 1

As discussed earlier, the central idea of Keynesian theory is that the equilibrium level of income and output is determined by the total aggregate spending in the economy. When this spending is too low to support a level of output that ensures full employment of all available workers, unemployment arises and the economy operates below its productive capacity. This situation is known as underemployment equilibrium.

Underemployment equilibrium describes a state where the economy's income level results in some resources, particularly labour, remaining unused or idle. If aggregate spending matches the level required for full employment output, the economy achieves full employment and reaches its production potential. Conversely, if aggregate spending exceeds this level, the output stays at full employment, but inflation emerges. Therefore, any level of output between full employment and one that causes unemployment can serve as an equilibrium point, depending on the level of aggregate demand.