CLASSICAL THEORY OF EMPLOYMENT

Presented by: Sumit Gupta Ankita Tiwari Pradeep Yadav

Classical theory of employment

The classical theory starts with the assumption that an economy functions at full employment and produces an output and income corresponding to the level of full employment. A long period unemployment can persist only due to interference of the free play of market forces by the government or by the private monopoly.

Assumption
Wage rates are flexibe in nature and and the operation of the free competition and price mechanism automatically removes unemployment by forcing the wage down. Increase in production increases not only the supply of goods, but also creates the demand for these goods by virtue of factor price payments. This is the essence of Says law.

SAYS LAW OF MARKET

The classical theory of employment is based upon the ideas , broadly incorporated in Says Law of Market. According to this law, supply creates its own demand for the product

Assumption of Says Law

Whatever income the economy generates is instantaneously spent either on consumption or on capital goods. That is income not consumed is automatically invested. There is, thus, a continuous flow of income, income becoming expenditure; expenditure creating income; and so on. There is perfect competition in product, factor and money markets.

Contd
There is no government interference in the functioning of the economy.
The amount of labour and capital can be raised to any extent in a free enterprise economy based on price mechanism.

Conti
New entrants have easy access into the market without dislocating the existing ones. They are also free to withdraw. Hence the size of the market is expandable.
It is a closed laissez-faire capitalist economy, which implies absence of trade or financial relationship with other economies.

Criticism of Says Law

Demand and supply may not be equal Role of rate of interest Function of flexible wages Practical experience

Keynes Criticism of Classical Theory:

Saving is a function of national income and is not affected by changes in the rate of interest. Thus, saving-investment equality through adjustment in interest rate is ruled out. So Says Law will no longer hold. The labour market is far from perfect because of the existence of trade unions and government intervention in imposing minimum wages laws. Thus, wages are unlikely to be flexible.

Conti
Wages are more inflexible downward than upward. So a fall in demand will lead to a fall in production as well as a fall in employment.

Keynes also argued that even if wages and prices were flexible a free enterprise economy would not always be able to achieve automatic full employment.

ASSUMPTION
1)short period 2)closed economy 3)fixed price 4)excess capacity is available 5)labour have money illusion 6)no time lag 7)selling and investment function

Effective demand
A)Aggeragate demand 1)consumption 2)propensity to consume 3)national income

B)Investment 1. Rate of return 2)marginal efficiency of capital 3)rate of interest