classical theory

Topics: Supply and demand, Unemployment, Keynesian economics Pages: 10 (2331 words) Published: November 24, 2013
 Classical theory of employment The Full employment Model-
Some of the aspects of classical theory are more relevant to the conditions prevailing in the developing countries and this theory highlights those factors which govern income and employment in these countries. While the Keynesian theory ------ the role of effective demand in the determination of income and employment. Classical theory-----In a free-market economy there was sufficient demand for the output produced.

Classical theory of employment-
It is based on two basic notions-

Say’ Law-
According to the classical theory propounded by Ricardo and Adam smith , levels of income and employment are governed by fixed capital stock on the one hand and wage-goods fund on the other. It may be noted in the beginning that the classical theory believes in full employment or near full employment prevailing in the economy. This belief of existence of full employment based on say’s Law. Say’s law given by French economist J.B.Say.

According to say’s Law “ Supply creates its own Demand” This implies that every increase in production made possible by the increase in the productive capacity or the stock of fixed capital will be sold in the market and there will be no problem of lack of demand. Therefore, Classical economists rule out the possibility of over production, and there is no problem in selling the output produced. According to this law, greater production automatically leads to a greater money income which creates the market for the greater flow of goods produced. Thus deficiency in demand being no problem, the process of capital accumulation and expansion of productive capacity will continue till all people are employed and there is no reason why the productive capacity created remains unutilized or underutilized. According to this law, the income which is not spent on consumer goods and thus saved will be investment expenditure. Therefore, Investments = Savings Therefore , the leakage caused by saving in the income flow is made up by the investment expenditure .In this way, a given productive capacity continues to be fully utilized and no problem of deficiency of demand arises. Classical economists thought that if price mechanism in a capitalist economy is allowed to work freely without any interference by the government there is always a tendency towards full employment in it.

According to the classical economists whenever there are lapses from full employment level, these are removed automatically by the working of free price mechanism.(Modern economist do not regard this aspect as valid and correct for the real world.) Basic Assumptions:

1. There is always enough expenditure or aggregate demand to purchase the total production at full-employment level of resources. Thus this theory disregarded the problem of deficiency of demand for purchasing goods produced at full-employment level of resources. 2. Whenever, deficiency of aggregate expenditure or demand arises , the prices, wages and interest would adjust quickly and automatically , so that equilibrium is resorted at full-employment level of output. Say’s law is based upon the fact that every production of goods also creates incomes equal to the value of goods produced and these incomes are spent on purchasing these goods. In other words, production of goods itself creates its own purchasing power .Therefore, Say’s law is expressed as ‘Supply Creates its own demand’ that is, the supply of goods produced creates demand for it equal to its own value with the result that the problem of general overproduction does not arise. In this way in say’s law , the possibility of lack of aggregate demand has not been visualized. The law expresses an important fact about the working of a Free-enterprise economy. The fact that the source of demand for goods →incomes earned by various factors of production→ employed for their...
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