criticism of classical theory of employment

Though the classical theory is perfectly logical in its content, but it has little practical relevance. The classical economists took full employment for granted, believed in the automatic adjustment of the economy, and, therefore, felt no need to present a proper theory of employment. Keynes challenged Say’s Law: Keynes criticised Say’s Law and proved that it … Each market involves a built-in equilibrium mechanism to ensure full employment in the economy. Keynes begins the General Theory with a summary of the classical theory of employment, which he encapsulates in his formulation of Say's Law as the dictum "Supply creates its own demand". Content Filtrations 6. Prohibited Content 3. Before publishing your articles on this site, please read the following pages: 1. Since the Keynesian Economics is based on the criticism of classical economics, it is necessary to know the latter as embodied in the theory of employment. According to this law, “Supply creates its own demand.” Dividing wage rate (W) by price level (P), we get the real wage rate (W/P). If community decides to increase saving at all levels of rate of interest, the saving curve will shift to the right to S1 curve. Those theories are Keynesian and Classical. 9. The main points of criticism of the classified theory are as follows: Keynes’ foremost attack was on the classical assumption of full employment. In the classical analysis, output and employment in the economy are determined by the aggregate production function, demand for labour and supply of labour. It may pass legislation recognising trade unions, fixing minimum wages and providing relief to workers through social security measures. Equality between saving and investment. (ii) Full employment means absence of involuntary unemployment. The classical theory of employment can be summarises in equation model given below: The description of the various equations in the model is as follows: 1. Whenever saving exceeds investment, aggregate demand decreases and income level declines. As we know that the seeds of scientific management were sown long before Taylor brought together several strands of thinking into a single methodology for applying scientific principles to the design and organization of work. The classical economists believed that money was demanded for transactions and precautionary purposes. Adam Smith wrote a classic book entitled, 'An Enquiry into the Nature and Causes of the Wealth of Nations' in 1776.Since the publication of that book, a body of classic economic theory was developed gradually. When the price level rises to OP1, the money wage also rises to OW1. 1. When a producer produces goods and pays wages to workers, the workers, in turn, buy those goods in the market. In this article we will discuss about:- 1. In Figure-3(A), MV curve is the money supply curve which also represents demand for goods. If there is not full employment in the actual life, then there is always a tendency towards full employment. In addition, the government should balance its income and expenditure. (iii) When, due to money illusion, money wages become rigid downwards. The supply of labour also depends on the real wage rate: SN =f (W/P), where SN is the supply of labour. Flexibility of wages always tends to maintain full-employment equilibrium. Thus Keynes integrated monetary and real sectors of the economy. Thus the classical view that fall in real wages will increase employment breaks down. This he did by forging a link between the quantity of money and the price level via the rate of interest. Classical economists were not completely unified in their theories, ideas, and assertions, including their beliefs or understanding of markets. According to Keynes, there may be full employment, over-full employment or under-employment. According to Pigou, reduction in money wages, through its downward effect on cost of production and prices, tends to increase employment. Thus both the demand for and supply of labour are the functions of real wage rate (W/P). Pigovian Formulation 5. It ignores the empirical facts of changing levels of employment in the real world. Copyright 10. But when more workers NfN2 are employed beyond the full employment level of output OQ1, the increase in output Q1Q2 is less than the increase in employment N1N2. The basis of the classical theory is Say’s Law of Markets which was carried forward by classical economists like Marshall and Pigou. Remove these obstructions, allow the natural working of the economic system, and the unemployment will automatically end. Saving (S) is an increasing function of rate of interest (i). THE KEYNESIAN MODEL 2. Keynes also criticised the classical version of saving-investment equality. Explanation of Classical Theory of Employment 5. The determination of output and employment in the classical theory occurs in labour, goods and money markets in the economy. In case of unemployment, a general cut in money wages would take the economy to the full employment level. When the money wage increases, the real wage also increases in the same proportion and there is no effect on the level of output and employment. At the full employment level, ON, the corresponding full employment output is OY. If the quantity of money increases, the MV curve will shift to the right as M1V curve. The classicists believed that saving and investment were equal at the full employment level and in case of any divergence the equality was brought about by the mechanism of rate of interest. The equilibrium of the money market explains the price level corresponding to the full employment level of output which relates Panel (E) and Panel (B) with MQ line. The equation tells that the total money supply MV equals the total value of output PT in the economy. Again, total income is partly spent on consumer goods (C) and partly saved (S). He mentioned three cases when the economic system does not remain self-adjusting: (i) When liquidity preference schedule becomes perfectly elastic (i.e., liquidity trap) as a result of the investors’ expectation that the rate of interest cannot fall further. Now at the original interest rate Oi, saving exceeds investment by EE2 which indicates the amount of overproduction. It follows that the money wage should be reduced in order to attain the full employment level in the economy. If saving exceeds investment, it means people are spending less on consumption. 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