Classical Theory 6e2i1u

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

Say’s Law French economist ‘Jeane Baptiste Say’ “Supply Creates it’s 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.

Say’s 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 Say’s 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

Pigou’s 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. • Say’s Law ineffective : Unemployment according to Keynes is on 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.