CLassical Theory Of Employment

• The classical economists belivedin the existence of full emplyment in the economy. 
• Classical economists such as J.S. MILL,MARSHALL,PIGOU etc.have supported this law by J.B. SAY.
• The classical economists believed in the existence of full employment in the economy. To them, full employme was a
normal situation and any deviation from this regarded as something abnormal.
• According to Pigon, the tendency of the economic system is to automatically provide full employmen in the labour market
when the demand and supply of labour are equal.
• Unemployment results from the rigidity in the wage structure and interference in the working of free marker system in the
form of trade union legislation, minimum wage legislation etc. 
• Full employment exists "when everybody who at the running rate of wages wishes to be Those who are not prepared to
work at the existing wage rate are not unemployed because employed."they are voluntarily unemployed.
• This full employment is a situation where there is no possibility of involuntary unemployment in the sense that people are
prepared to work at the current wage rate but they do not find work.
  Classical Theory Of Employment
Assumptions 
CRITICISM
1) There is the existence of full 1)  Equilibrium level need not be full
employment without inflation. employment level.

2) There is a laissez-faire capitalist 2) Rate of interest is not the true

determinant of saving and investment.
economy without government interference. 
3) Theory is applicable only in the long
3) It is a closed economy without foreign run. 
trade.
4) Full employment is not a normal
 4) Wages and prices are perfectly flexible. situation.

Determination  of output
and employment
Labour market equilibrium
Determination of output and employment
• In classical theory ,output and employment are determined
by the production function and dl & sl in the economy..
• Production function Q=f(K,T,N) where Q is total outut ,K
is capital stock, T is technical knowledge and N is number
of workers.
          Labour market equlibrium
• In the labour market, the demand for labour and the supply
of labour determine the level of output and employment.
•  The classical economists regard the demand for labour as
the function of the real wage rate: DN =f (W/P) Where DN
= demand for labour, W = wage rate and P = price level
•  Dividing wage rate (W) by price level (P), we get the real
wage rate (W/P).
• The demand for labour is a decreasing function of the real
wage rate, as shown by the downward sloping DN curve in
Fig. 2. It is by reducing the real wage rate that more 
workers can be employed.
 Wage price flexibility
The classical economists believed that there was always full employment
in the economy. In case of unemployment, a general cut in money wages
would take the economy to the full employment level.
This argument is based on the assumption that there is a direct and
proportional relation between money wages and real wages.
Pigou explains the entire proposition in the equation: N = qY/W. In this
equation, N is the number of workers employed, q is the fraction of
income earned as wages, Y is the national income and W is the money
wage rate
Wage price flexibility
Goods market equlibrium
The goods market is in equilibrium when saving equals investment. At
that point of time, total demand equals total supply and the economy is
in a state of full employment. According to the classicists, what is not
spent is automatically invested.
S=f(r) …(1) I=f(r) …(2) S = I Goods market equilibrium
Where S = saving, I = investment, and r = interest rate.
 Money market equlibrium
The money market equilibrium in the classical theory is
based on the Quantity
 Theory of Money which states that the general price level
(P) in the economy depends on the supply of money (M). 
The equation is MV= PT, where M = supply of money,
V=velocity of circulation of M, P = Price level, and T =
volume of transaction or total output.
The  equation tells that the total money supply MV equals
the total value of output PT in the economy.
Assuming V and T to be constant, a change in the supply
of money (M) causes a proportional change in the price
level (P). Thus the price level is a function of the money
supply: P = f (M).
 SAY'S LAW OF MARKET 
• Say's Law of Markets states that the supply of a good or service creates
demand for that good or service, i.e., supply creates its own demand.
•  According to Say's Law, any economic agent must first produce goods and
services that before they can consume, i.e., a person's ability to demand goods
and services is a direct result of the production activities they've undertaken. 
• Since production comes first and demand follows the wealth created from
production, Say's Law infers that it is important to look at the supply side if
there is a fall in consumption. 
 SAY'S LAW OF MARKET 
ASSUMPTIONS
1) No hoarding i.e. people spend all the
income on either consumer goods or
capital good i.e.S=I.
 2) The wages and prices of goods are
free to move to whatever level the supply
and demand dicatate.
 3) state is neutral i.e. state doesnot
interfere in the economic activities.
Say‘s law of market hold good
in a monetary economy.
• According to them money serves as a
medium of exchange when a producer sells
his products , he gets income in terms of
money.
• He will spend this money to buy other
goods and services.
• The value of demand so created will be
equal to the value of goods supplied.
 Understanding says law of market
• According to the Law of Markets, a person’s ability to demand goods and services is a
direct result of production activities that they’ve undertaken.
• They earn an income either through the production and sale of physical assets or by
supplying labor to capital owners.
• By choosing to produce a certain good, they are indirectly creating the demand for
those goods and services that they intend to buy with their earned income.
Conversely, if one did not demand anything, they would not want to work.
• We conclude that in long run there is a tendency towards equality of aggregate supply
and aggregate demand.
 Keynesian Criticism of Say’s Law

• General overproduction is possible

• General unemployment is possible.
• Generate Coordination between economic factors is not possible wherefore
state intervention becomes necessary.
• Equality between saving and investment is not possible.
 KEYNESIAN THEORY OF
EMPLOYMENT
• According to Lord Keynes, there is not always full employment in a developed capitalist 
economy. In fact, an unemployment situation can be found in every economy
• The main reason for this unemployment is fall in AD or effective demand. Unemployment
can  be removed and full employment can be restored by increasing the effective demand.
• Effective demand is that level of aggregate demand (AD) at which it is equal to aggregate
supply (AS).
• Keynes believed that it is the 'aggregate demand' (effective demand), not wages, price
level  and rate of interest, which determine unemployment
 c
KEYNESIAN THEORY OF 
EMPLOYMET
ASSUMPTIONS
1) Keynes confines his analysis to the
short period.
2) He assumes that there is perfect
competition in the market.
3) He carries out his analysis in the
closed economy, ignoring the effect
of foreign trade.
CRITICISMS
1)  keynes theory of employment is
called the effective demand theory of
employment.
2) Keynesian econommic analysis is
mainly a static analysis.
3) Keynesian theory is a short run
economic analysis
Aggregate Supply :-
According to Keynes Aggregate Supply is equal to the national income at
market price . In other words national income is equal to the price of goods
and services produced in a country .The national income is divided into
three parts consumption, savings and taxes .
Aggregate Demand :-
Aggregate demand is the amount of consumption and amount of investment
expenditure at each level of income. There are two components of aggregate
demand
1. Consumption expenditure
2. Investment expenditure
 Further explanation of theory of income and
employment

• The basic concept of keynesion theory is thatlevel of employment in a

country is determined by the aggregate demand and aggregate
supply.Effective demand refers to that level of aggregate demand at which
it is equal to aggregate supply.
•  Example: by employing one lakh labourer in a country at any given time
the aggregate supply is worth rs 100 cr. And the aggregate demand at the
very time period is also rs 100 cr, then in that situation aggregate demand
price will be equal to aggregate supply price.
Policy Implications of Keynesian Theory:
I. Reform of Capitalism: Keynesian theory has demonstrated that in a
capitalist’s economy, unemployment, and not full employment.
II. Government Intervention: Keynes has no faith in the policy of laissez-
faire and has shown that the state of full employment is not automatically
achieved. He recommended state intervention to raise effective demand in
order to increase the level of employment in the economy.
 Policy Implications of Keynesian Theory:
III. Monetary Policy not Reliable:-Employment can be increased by increasing
the quantity of money (i.e., cheap money policy) because it will reduce rate of
interest and increase private investment. But Keynes did not consider cheap
money policy as a reliable policy to promote private investment in a situation of
depression and unemployment.
IV.Objective of Full Employment:- The present-day popularity of the objective of
full employment is also attributed to Keynes. There is hardly any nation, planned
or unplanned, which has not accepted full employment as the ultimate goal of its
economic policy.