Classical Theory of Output

and Employment
Postulates
Always full employment.
In the State of Equilibrium.
Money Does not Matter.

Assumptions
Laissez faire
Non Intervention of the
Government
Perfect Competition
Market Mechanism
Consumer and Producers freedom

Says Law
French economist Jeane Baptiste Say
Supply Creates its own demand.
In this economy there cannot be over
production or under production. They
produce what they consume and they produce
as much as they consume. If there is
production there is income and if there is
income their is demand for goods including
demand for goods whose productin creates
income thus supply creates its own demands.

Says Law
Full Employment There is no unemployment
in the capitalist economy. Full employment
with equilibrium. Total production is always
sufficient to maintain the economy at full
employment level . Unemployment is
temporary. Frictional unemployment is due
to market imperfections, immobility of
labor seasonal agricultural activities and
so on.

Saving Investment
All income is spent. The leakage is saving
which is equal to investment. S = I. if there
is any divergence then equality is
maintained through rate of interest higher
the interest rate more is the saving and
vice - versa

Classical Quantity Theory of

Money
Validity of Says law depends on quantity
theory of money.
MV = PT
Money acts as medium of exchange only the
relation between quantity of money total
output price level

Pigous version
In labour market Perfect competition .
Economic system provides automatic
full employment. Free mechanism with
no intervention and trade unions lead
to full employment. N = qy/w N no. of
workers employed q- is the fraction of
income earned ad wage. Y is national
income. And w money wage rate N
increase there is decrease in wages.

Criticisms
Wage bargain between workers and employers
determines real wage and not the money wages.
It is the level of wages which determines the
employment.
No full employment there is only
underemployment equilibrium. Full employment
equilibrium is only rate possibility.
Says Law ineffective : Unemployment according
to Keynes is on account of the failure to spend
current income on consumption and investment
goods.

Criticisms
Deficiency of demand While suggesting a
flexible wage policy the classical writers were
greatly pre-occupied with the fact that the
supply function of labour would get shifted to
right, but they ignored that ADF is reduced and
there is no further generation of employment.
Real balance effect : or Pigou effect When there
is reduction in wages and prices,will increase
the real value of the monetary assets of
community. This will cause a continuing
reduction in the amount of saving and a
resultant strengthen of spending or aggregate
demand which will bring equilibrium at full
employment . Keynes, Patinkin, Samuelson and
Kurihara say downward wage-price flexibility will

continuation
Will generate an adverse exceptional
pattern
Which will force both the consumers and
investors to postpone their plans of
expenditure.
Neglect of speculative demand for money.
Saving investment relationship
Dichotomy between real and monetary
sectors.