Determination of Output and

Employment in the Classical

Model
Student Name: College UID: CU Registration No: CU Roll No:

1. Soumyadeep Paul 0704210051 017-1111-0565-21 213017-21-0037

2. Utsa Basu Das 0704210054 017-1211-0523-21 213017-11-0011

3. Shreyam Dey 0704210048 017-1111-0551-21 213017-21-0027

 Introduction
The classical model says that the economy is at full employment all the time and
that wages and prices are flexible.​
​
It focused on economic growth and freedom, advocating laissez-faire ideas
and belief in free competition for efficient outcome.​
​
It stresses the importance of limiting government intervention and striving to keep
markets free of potential barriers to their efficient operation.​
 Classical Revolution
Classical economics emerged as a revolution against
mercantilism. Mercantilism was prevalent in Europe during the sixteenth
and seventeenth century.​
​
In contrast to the mercantilists, classical economists emphasized
the importance of real factors in determining the wealth of nations and
stressed the optimizing tendencies of the free market in the absence of state
control.​
​
Adam Smith in his famous book, " Wealth of Nations"(1776) marked
the beginning of the classical period which continued till the first half of
the 20th century.​
​
Other notable classical economist are David Ricardo, J.B Say , T.R
Malthus, John Stuart Mill.​
Features Of The Classical Model
• Effect of a change in money supply:
Employment, real wage rate, real income and
the interest rate are independent of the
quantity of money.​

​
• Effect of a shift in the production function:
The upward shift implies an increase in the
marginal product of labor.​

​
• Shift of labor supply curve​. Effect of rightward shift of Labor Supply curve
The Production Function

• Classical model starts with the production

function Y=F(L,K) where Y is the output, K
is the fixed stock of capital and L is the
quantity of labor. In the short run, capital is
constant.​

​
• The production function shows the
relation between the total quantity of
output and the number of labors, provided
that capital is fixed.​

Production Function and MNP Curves

 Labor Demand
MCi=W/MPNi.............(i)​
P=MCi.........(ii)​

Substituting we get (ii) in (i) we get :-​

           P=W/MPNi​
Therefore we can also write :-​
    MPNi=W/P​
​
(Where, MPNi=Marginal productivity of labor ,
W= Wage rate ,
P= Price level​,
MCi= Marginal Cost,
W/P= real wage rate)​
​
This equation states the relationship between Marginal productivity
of labor and real wage rate. ​
Hence labor demand has an inverse relationship with the real wage rate.​
Labor Demand for a Firm
 Labor Supply
Labor is supplied by individual workers who tries to maximize utility.​
​The level of utility is positively related to real income.​
​A worker has a trade off between leisure and work.​
​
In the graph alongside, ​
Labor is measured in the horizontal axis(at intercept leisure being 24
hours), and real wage rate is measured on the vertical axis.​
(The slope of the budget line is the real wage and as real wage rate increases
the budget line becomes steeper)​
​
The indifference curve shows the utility derived from the combination of
work and leisure.​
We know that higher IC provides higher utility hence a rational worker
would try to achieve the 'northernmost' IC which in turn decreases his
leisure.​
​
Hence, deriving the supply curve from the above indifference curve we get a
positively sloped supply curve.​
Therefore supply of labor is positively related to real wage rate​.

Individual Labor Supply Decision

 Features of Labour Supply
• The wage variable is the real wage.​

• If the real income increases leisure may become desirable to any

further increment in income. Hence the supply curve might bend
backwards. ​
 Eqilibrium Output and Employment
Equilibrium output and employment holds
true when -- ​
Ns = Nd​where,
Ns=g(w/p)​
Nd= f(w/p)​

These relationships, together with the

equilibrium condition for the labor market
determine output, employment and the real
wage which are the endogenous variables in 
the model.​
​
 Determinants of Output and Employment

Factors that determine output and employment are

those factors that determine the position of labor
supply and demand curves and the position of the
aggregate production function.​

Any technical improvement that increases

production of the good shifts the labor demand
curve.​

Population increase or workers preferences

regarding leisure and labor will have its effect on
the supply curve.​

In classical model, the levels of output and

employment are determined solely by supply
factors.​

Labor Market Equilibrium and the Money wage

 Aggregate Supply Function
To construct the aggregate supply curve we cannot
assume that the money wage remains fixed as output and
labor input are varied to maintain equilibrium.
​ Paid Search
In the previous graph we see that equal changes in
price leads to equal change in wage rate resulting the
real wage rate to be constant making Organic Search
the aggregate supply curve to be vertical.​

The vertical supply curve illustrates the supply- Referral

determined nature of output in the classical model.​

Classical Aggregate Supply Curve

 Conclusion
The main feature of the classical model is the Supply-determined nature of output
and employment. This property follows from the vertical aggregate supply curve.
There are also two assumptions implicit in this classical representation of the labor
market. They are:

• Perfectly flexible prices and wages. For whatever time period we assume that
the equilibrium model determines employment and output, equilibrium must be
achieved.

• Perfect information on the part of all market participants about market prices.

These two assumptions, essential for the nature of the classical equilibrium theory
of employment and output, are the elements of classical theory that Keynes
attacked.
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