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Classical Theory Of Employment

 Classical Theory of Employment


            The classical economists believed in the existence of full employment in the economy. To them, full employment was a normal situation and any deviation from this regarded as something abnormal. According to Pigou, the tendency of the economic systems is to automatically provide full employment in the labour market when the demand and supply of labour are equal. Unemployment results from the rigidly in the wage structure and interference in the working of free market system in the form of trade union legislation, minimum wage legislation etc.

Its Postulations

  1. There is existence of full employment without inflation

  2. There is a laissez faire capitalist economy without government interference

  3. It is a closed economy without foreign trade

  4. There is a perfect competition in labour and product markets

  5. Labour is homogenous

  6. Total Output of the economy is divided between consumption and investment expenditure

  7. The quantity of money is given and money is only the medium of exchange

  8. Wages and Prices are perfectly flexible

  9. There is a perfect information on the part of al market participants

  10. Money wages and real wages are directly related and proportional

  11. Capital Stock and technical knowledge

  12. The law of diminishing returns operates in production

  13. It assumes long run

Say’s Law of Markets

     Say’s law of markets is the core of the classical theory of employment. There cannot be general overproduction and the problem of unemployment in the economy. If there is general overproduction in the economy, then some labourers may be asked to leave their jobs.

    The problem of unemployment arises in the economy in the short run. In the long run the economy will automatically tend toward full employment when the demand and supply of goods become equal. When a producer produces goods and pays wages to workers, the workers in turn buy goods in the market. Thus the very act of supplying goods implies a demand for them. It is in this way that supply creates its own demand.

Determination of Output and Employment

     In the classical theory output and employment are determined by the production function and the demand for labour and the supply of labour in the economy. Given the capital stock, technical knowledge and other factors, a precise relation exists between total output and amount of employment, i.e. number of workers. This is shown in the form of the following production function.

                                    Q         =          f (K,T,N)

    Where, total output Q is a function (f) of capital stock (K), technical knowledge (T) and the number of workers (N).

    Given K and T, the production function becomes Q = f (N) which shows that output is a function of the number of workers, output increases as the employment of labour arises.

    But after a point when more workers are employed, diminishing marginal returns to labour start, where the curve Q = f (N) is the production function and the total output OQ1 corresponds to the full employment level NF. But when more workers N1, N2 are employed beyond the full employment level of output OQ1, the increase in output Q1Q2 is less than the increase in employment N1N2. It is represented in the above diagram.

Criticism of Classical Theory

  1. Underemployment Equilibrium

    Keynes rejected the fundamental classical assumptions of full employment equilibrium in the economy. He considered it as unrealistic. He regarded full employment as a special situation. The general situation in a capitalist economy is one of underemployment. This is for the reason that the capitalist society does not function according to Say’s Law and supply always exceeds its demand.

    We find millions of workers are prepared to work at current wage rate and even below it, but they do not find work. Thus the existence of involuntary unemployment in capitalist economies proves that underemployment equilibrium is a normal situation and full employment equilibrium is abnormal and accidental.

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