Classical Theory of Employment PDF

Unit - 3 The Classical Theory of Employment S.Y.B.Com. (Semester – III) Sub:- Business Economics (Macro) Presented by,...

Unit - 3 The Classical Theory of Employment S.Y.B.Com. (Semester – III) Sub:- Business Economics (Macro) Presented by, Dr. Madhuri Vartale NET,PGDF.T.,M.Phil.,PhD. Dr. D. Y. Patil Arts, Commerce and Science College, Pimpri, Pune The classical theory of Employment\S.Y.B.Com 1 KEY CONCEPTS OF THE THEORY Say‟s law of Market Full Employment Laissez fair Policy Labour Market Equilibrium Capital Market Equilibrium Money Market Equilibrium The classical theory of 2 Employment\S.Y.B.Com INTRODUCTION  The classical economists hypothesized that a free enterprise economy would always tends toward full employment.  The economy should adopt a policy of laissez faire (non-interference of the government)  The classical economists follows the Adam Smith‟s Doctrine (invisible hand concept) The classical theory of 3 Employment\S.Y.B.Com  TWO BASIC CONCEPTS OF THE THEORY 1. The Say’s law of Market:- “Supply creates its own demand”, its mean that an increase in production automatically increases money income and there is no overproduction(excess supply) or under consumption (shortage in demand) because supply creates its own demand.at the same value. 2. Wage-Price Flexibility and Full Employment:- According to the classical economists, there is no possibility of involuntary unemployment in a capitalist economy. All those who were willing to work will get jobs at the existing market wage rate. The classical theory of 4 Employment\S.Y.B.Com  FULL EMPLOYMENT Spencer says, ”Full employment is a situation in which everyone who wants to work is working except those who are frictionally and structurally unemployed.” Frictional Unemployment:- It is a temporary phase of unemployment in a dynamic economy. It occurs due to immobility of labour, shortage of raw material, shortage of power, breakdown of machinery etc. Structurally unemployment :- It is a direct result of mis- match of work and work skill. There are many problems like shortage of supply of factors of production. It could be happen in long run period. The classical theory of 5 Employment\S.Y.B.Com  FULL EMPLOYMENT Lerners says, ’Full employment is a situation in which all those who are able to and want to work at the existing rate of wage jet work without any undue difficulty.’ Hansen,’ Full employment implies absence of involuntary unemployment (involuntary unemployment means people are ready to work at existing wage rate but they do not get the jobs).’ The classical theory of 6 Employment\S.Y.B.Com  ASSUMPTIONS OF THE THEORY  Capitalist closed economy.  Classical theories are believed in long run period without inflation.  There is full employment situation.  Perfect competition in labour market, money and product markets.  There are homogeneous labours. Ready to work at the existing wage rate.  The total output of the economy is parts of consumption and investment expenditure.  Money is the medium of exchange.  No technological change.  Prices and wages are flexible in nature.  Saving is equal to investment.  The law of diminishing marginal returns is applicable to agriculture sector. The classical theory of 7 Employment\S.Y.B.Com Labour Market Equilibrium When labour market is in equilibrium , we can determine the level of employment and the real wage rate. Supply of labour increases when the raise in wage rate. The full employment prevails at the equilibrium real wage rate. The classical theory of 8 Employment\S.Y.B.Com OUTPUT DETERMINATION Section (A) of the figure shows Labour Market equilibrium in the classical model. [Sufficient wage flexibility ensures that demand for labour is equal to its supply.] Section (B) shows the output determination at the full employment level. [with fixed capital stock and unchanged technology, The total output at full employment is equal to equilibrium value of national income.] The classical theory of 9 Employment\S.Y.B.Com  OUTPUT DETERMINATION Full employment is a general characteristics in a capitalist economy. Level of employment refers to equilibrium of demand and supply of labours in the economy. Production is function of number of labours. Equilibrium level of aggregate output and employment is given by production function and labours demand and supply function respectively. Saving is equal to the investment, so unemployment for short period in the economy, but it can adjusting forces and restore full equilibrium. Aggregate demand is equal to aggregate supply(Full employment level) The classical theory of 10 Employment\S.Y.B.Com  OUTPUT DETERMINATION W/P In classical model, employment depends on real wage rate. The ratio of nominal wage rate to the general price level. Where, W- nominal wage rate P – general price level The classical economists assumed perfect competition and diminishing marginal returns to scale. So the firm will reach the point of optimal purchase of labour by equating MPl with the real wage rate. W/P= MPl (marginal productivity of labour) [as shown in the figure.] till full employment position achieved. The classical theory of 11 Employment\S.Y.B.Com CAPITAL MARKET EQUILIBRIUM In the classical model change in the rate of interest tends to change in savings and investment and ensures at full employment position. The classical theory of 12 Employment\S.Y.B.Com  MONEY MARKET EQUILIBRIUM (FISHER QUANTITY THEORY OF MONEY) This theory expresses how the supply of money determines the aggregate price level in the economy. MV=PT M= the quantity of money V= velocity of circular money Y= aggregate income (GDP) P= the aggregate price level The classical economists assumed that the aggregate output(Y) remains constant in short run due to assumption of full employment, constant technology, price-wage flexibility. The classical theory of 13 Employment\S.Y.B.Com  MONEY MARKET EQUILIBRIUM (FISHER QUANTITY THEORY OF MONEY) The effect of an increase in the If money supply increases money supply from m1 to m2 (velocity A g g AS remains constant) Aggregate demand r e g a t e increases from AD1 to p r AD2. i c e As a result, Aggregate l output remains constant at Yf e v e l AD2 =m2v Inflation is a purely AD1=m1v monetary phenomenon. o Yf Aggregate output Money has a neutral effect on real variables. The classical theory of 14 Employment\S.Y.B.Com IMPLICATIONS OF CLASSICAL THEORY importance to full employment Involuntary unemployment is absent Under perfect competition general unemployment is not possible. Decrease in Money wages tends to decrease the real wages also. Wage and price flexibility occurs according to the Say’s law of Market. Due to say’s law of market , there is no overproduction and general unemployment issues. People spend their entire income on consumption and investment Savings are equal to investment Rate of interest can be changed as accordance to equalize he savings and investments The classical theory of 15 Employment\S.Y.B.Com CRITICISM ON CLASSICAL THEORY Prof. J.M.Keynes wrote „General Theory of employment, rate of Interest and Money‟ in 1936. In this book he, criticized on the classical theory of Employment and strongly clash with Say‟s law of Market. Keynes argued that during depression , Say‟s law does not work. According to Keynes, equilibrium income and full employment income are not the same thing. Keynes also criticized on Pigoue‟s approach regarding wage cut. He trust on involuntary unemployment arises due to deficiency of demand due to fall in income of the labors. The determination of aggregate output and employment level called as general equilibrium. He rejected laissez fair policy He believes in short run so criticized that the theory ignored problems in short period. The classical theory of 16 Employment\S.Y.B.Com  The classical theory of 17 Employment\S.Y.B.Com