1. The Classical theory of employment assumes full employment, equilibrium in the goods market, and that supply creates its own demand.
2. Under the Classical model, the level of employment and output are determined by the intersection of the labor supply and demand curves.
3. The Classical model views money as neutral, with real variables like output and employment determined independently of monetary factors in goods and labor markets.
1. The Classical theory of employment assumes full employment, equilibrium in the goods market, and that supply creates its own demand.
2. Under the Classical model, the level of employment and output are determined by the intersection of the labor supply and demand curves.
3. The Classical model views money as neutral, with real variables like output and employment determined independently of monetary factors in goods and labor markets.
1. The Classical theory of employment assumes full employment, equilibrium in the goods market, and that supply creates its own demand.
2. Under the Classical model, the level of employment and output are determined by the intersection of the labor supply and demand curves.
3. The Classical model views money as neutral, with real variables like output and employment determined independently of monetary factors in goods and labor markets.
given by JM Keynes The Classical theory is not a single theory which may be called as Classical theory. They put forward some Postulates. The modern economists worked on these postulates. These postulates are- There is always full employment. In this state there may be frictional and voluntary unemployment The economy is always in equilibrium Acc. To them full employment of resources generates incomes on the one hand and goods and services on the other. The value of goods and services is always equal to income. There is no general overproduction and no general underproduction There is no general overproduction and general underproduction This postulate is based on the assumption that the economy works on the principle of laissez - faire
Money does not matter The classical economists treated money only as a medium of exchange. Acc. To them the role of money only as a facilitator of transactions. It does not play any role in determination of output and employment. The levels of output and employment are determined by the availability of real resources, i.e . labour and capital
Says Law The law states that supply creates its own demand. The logic is that supply of goods itself generates sufficient income to generate a demand equal to the supply of goods. This law is regarded as the core of classical macroeconomic thought A laissez faire system is one in which There is complete absence of govt. control or regulation of private enterprise, except to ensure free competition; There is complete absence of monopolies and restrictive trade practices if there is any it is eliminated by law; There is complete freedom of choice for both the consumers and the producers; The market forces of demand and supply are fully free to take their own course Classical Model of Employment As reconstructed by Keynes it consists of two components Aggregate production function Labour supply and demand function
Aggregate production function Y= f(K,L) where y = aggregate real output K = capital(fixed) L = Labour (homogenous) required to produce Y assumptions - stock of capital K is fixed Technology used by the firms is given Population is constant Successive units of labour yields diminishing returns - Y/ L, decreases with increase in employment (graph) Labour market : labour supply and demand Acc. to the Classical Theory of Employment, equilibrium of Labour market determines the level of employment. The level of employment determines the level of national output Level of employment is determined by labour and demand supply functions and so also the wages Labour supply Supply of labour depends on real wages L S = f(W r ), L s /W s > 0 (graph) Labour demand Demand for labour depends on its marginal revenue productivity of labour and real wage L d = (W r , MRP L ) , given the wage rate, then MRP L =
MPP L X P, in perfectly competitive market, P is constant, therefore, MRP L =
MPP L
MPP L can be taken to represent labour demand function. So in order to derive labour demand curve
MPP L has to be derived. This can be derived from the production function . Algebraically Q = bL cL 2
Lets assume, Q = 55L 5L 2 The 1st derivative of the production function gives the MPP L
MPP L decreases with increase in employment A profit maximising firm employs where real wages (W r ) equals
MPP L i.e. MW r =
MPP L (MC = MR)
Aggregate production schedule and labour supply and demand curves can be used to determine full employment and aggregate real output in in classical model
Intersection of demand and supply curves determines simultaneously equilibrium wage rate and full employment of labour. Given the short run conditions, this is the full level of employment of labour Determination output can be shown by placing the production function on the same scale, with labour market equilibrium (graph)
An important feature of classical model is that factors operating on the supply side of the market determine the level of employment and output Equilibrium in the money market Goods market equilibrium gives equilibrium rate of interest, saving, and investment Interest rate and savings is directly related Interest rate and investment is inversely related Equilibrium level of employment, real wage rate, real output are determined independently. Money market will only determine nominal income, whereas real income is determined in the goods market
Given the real income, nominal income will enable to determine price level The money market M d = kPy - demand for money K = constant P = price level Y = real national income or output M s = supply of money Equilibrium condition - M d =
M s
The classical model money market conditions will only determine the general price level Thus all the nominal values can be determined from the nominal Py o This is
referred to as Classical Dichotomy separating real and monetary sectors. Thus real variables of the system are determined independently of the money market conditions