Classical Theory of Employment

Topics: Supply and demand, Keynesian economics, Macroeconomics Pages: 16 (5267 words) Published: April 29, 2011

The Classical Theory Of Employment amd output

The fundamental principle of the classical theory is that the economy is self-regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources are fully employed. While circumstances arise from time to time that cause the economy to fall below or to exceed the natural level of real GDP, self-adjustment mechanisms exist within the market system that work to bring the economy back to the natural level of real GDP. The classical doctrine—that the economy is always at or near the natural level of real GDP—is based on two firmly held beliefs: Say's Law and the belief that prices, wages, and interest rates are flexible.

Classical theory of employment and output is based on the following two basic notions:  

1.Say's Law
2.Price-wage flexibility

Say’s Law
* Say’s Law is the foundation of classical economics.  Assumption of full employment as a normal condition of a free market economy is justified by classical economists by a law known as ‘Say’s Law of Markets’. * It was the theory on the basis of which classical economists thought that general over-production and general unemployment are not possible.

Basic Assumptions of Say’s Law:

* (a)   Perfectly competitive market and free exchange economy. * (b)   Free flow of money incomes.  All the savings must be immediately invested and all the income must be immediately spent. * (c)  Savings are equal to investment and equality must bring about by flexible interest Rate. * (d)   No intervention of government in market operations, i.e., a laissez faire economy, and there is no government expenditure, taxation and subsidies. * (e)   Market size is limited by the volume of production and aggregate demand is equal to aggregate supply. * (f)   It is a closed economy.

Classical theory * Classical macroeconomic theory—
a view of the macro economy as
being self-adjusting
full employment
maximum output
without government intervention.
* Classical theory was dominant from the late 18th century through the early 20th century (the Great Depression).

Classical Theory (cont’d)

* Classical theory
Adam Smith
Wealth of Nations in 1776

Classical Theory of Employment

Who are the classical Economists? :
The term classical economist was coined by Karl Marx to describe the economist who accepted labour theory of value, as propounded by David Ricardo. Later Keynes popularized this term

The out put and Employment in classical Theory * With a given production function and initial equilibrium MPP= W∕P An increase in employment is not possible without decrease in wages. The amount of labour supplied is a direct function of real wage rate . The intersection of supply and demand curve for labour will determine the level of employment

The out put and Employment in classical Theory

* Frictional unemployment is consistent with full employment


The Classical Approach: If the principle of supply creating its own demand is made applicable to the labor market, one would wonder what its effect would be. The number of workers may be in excess of the available job...
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