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CLASSICAL THEORY OF INCOME AND EMPLOYMENT
DETERMINATION
MACRO ECONOMICS
MACRO ECONOMICS
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SHASHI AGGARWAL ECONOMICS AND LAW CLASSES VIDEO
LECTURE
Ø MEANING
- CLASSICAL THEORY OF EMPLOYMENT IS BASED
ON SAY’S LAW OF MARKETS AND ON THE ASSUMPTIONS OF FLEXIBILITY OF WAGES,
RATE OF INTEREST AND PRICES. ACCORDING TO SAY’S LAW OF MARKET” SUPPLY
CREATES ITS OWN DEMAND”.
- ACCORDING TO
CLASSICAL THEORY OF INCOME , FULL EMPLOYMENT IS A NORMAL FEATURE OF A
CAPITALISTS ECONOMY. IT MEANS IF THERE IS UNEMPLOYMENT IT IS ONLY FOR
SHORT DURATION . ECONOMY ACHIEVES FULL EMPLOYMENT THROUGH THE FREE PLAY OF
MARKET FORCES.
- IN A SITUATION OF UNEMPLOYMENT,LABOUR DEMAND
IS LESS AS COMPARED TO LABOUR SUPPLY. AT LOWER WAGES PRODUCERS WILL EMPLOY
MORE LABOURERS. ECONOMY WILL REACH THE LEVEL OF FULL EMPLOYMENT.
- MEANING OF FULL
EMPLOYMENT
- ACCORDING TO
LERNER,” FULL EMPLOYMENT IS A SITUATION IN WHICH ALL THOSE WHO ARE ABLE
AND WANT TO WORK AT THE EXISTING RATE OF WAGE GET WORK WITHOUT ANY UNDUE
DIFFICULTY.
- FULL EMPLOYMENT
IS USED TO SIGNIFY IN WHICH ORDINARILY ALL THOSE PEOPLE WHO ARE WILLING TO
WORK AT THE PREVAILING WAGE RATE GET WORK
- SPENCER ,” FULL
EMPLOYMENT IS A SITUATION IN WHICH EVERYONE WHO WANTS TO WORK IS WORKING
EXCEPT FOR THOSE WHO FRICTION ALLY AND STRUCTURALLY UNEMPLOYED.”
- FULL EMPLOYMENT
IS NOT SITUATION OF ZERO UNEMPLOYMENT. SOME SORT OF UNEMPLOYMENT EXIST. IT
IS CALLED NATURAL RATE OF UNEMPLOYMENT.
- FULL EMPLOYMENT
IMPLIES ABSENCE OF INVOLUNTARY UNEMPLOYMENT
- ESSENTIAL
BASICS OF CLASSICAL MODEL
- THE EQUILIBRIUM OUTPUT AND EMPLOYMENT IS AUTOMATICALLY DETERMINED BY THE FREE PLAY OF
MARKET FORCES OF DEMAND AND SUPPLY. BASIC ASSUMPTION OF THE CLASSICAL
ECONOMISTS. NO INTERFERENCE BY THE GOVERNMENT. THEY EXPLAINED THEIR
OPINION WITH REFERENCE TO SAY’S LAW OF THE MARKET WHICH STATES THAT SUPPLY
CREATES ITS OWN DEMAND. AND S = INVESTMENT
- FREE PLAY OF
THE MARKET FORCES AND SITUATION OF FULL EMPLOYMENT: ANOTHER VITAL
COMPONENT OF THE CLASSICAL THEORY OF INCOME AND EMPLOYMENT IS THAT IN FREE
ECONOMY EQUILIBRIUM LEVEL OF OUTPUT IS ASSOCIATED WITH A SITUATION OF FULL
EMPLOYMENT.
- ASSUMPTIONS
- RATIONAL MAN:
EVERY MAN IS RATIONAL AND DESIRES MAXIMUM SATISFACTION
- LAISSEZ FAIR:
ECONOMY IS FREE FROM ANY KIND OF INTERFERENCE BY THE STATE
- CLOSED ECONOMY:
NO FOREIGN TRADE
- PERFECT
COMPETITION
- CONSTANT
TECHNOLOGY:NO CHANGE IN THE SHORT PERIOD IN THE TECHNIQUE OF PRODUCTION
- MONEY IS ONLY A
MEDIUM OF EXCHANGE
- FLEXIBILITY OF
PRICES:-WAGES,INTEREST AND PRICES ARE FLEXIBLE
- RELATION
BETWEEN MONEY AND REAL WAGES:-DIRECT AND PROPORTIONAL REALTION BETWEEN
MONEY WAGES AND REAL WAGES
- EQUALITY OF
SAVING AND INVESTMENT
- LAW OF
DIMINISHING RETURNS: PRODUCTION IS SUBJECT TO LAW OF DIMINISHING RETURNS.
- DETERMINATION
OF EQUILIBRIUM INCOME AND EMPLOYMENT
- VOLUME OF
OUTPUT DEPENDS ON VARIOUS FACTORS OF PRODUCTION SUCH AS CAPITAL,LABOUR AND
TECHNOLOGY. PRODUCTION FUNCTION EXPRESSED THE RELATION BETWEEN
FACTORS OF PRODUCTION AND THE VOLUME
OF PRODUCTION.
- P =F( L,K,N,T)
AND IN SHORT CAPITAL (K),LAND(L) AND PRODUCTION TECHNIQUE REMAINS
CONSTANT. VOLUME OF PRODUCTION IS
A FUNCTION OF EMPLOYMENT.
- Y = f(N)
- DIAGRAM
- D
-
Y1
- EXPLANATION
- DIRECT
RELATIONSHIP BETWEEN THE LEVEL OF EMPLOYMENT AND OUT OF INCOME.
- VOLUME OF OUTPUT INCREASES WITH INCREASE IN THE LABOUR EMPLOYMENT. AND
VICE VERSA. BUT AFTER A POINT MARGINAL PRODUCT OF LABOUR STARTS DIMINISHES
BECAUSE OF OPERATION OF THE LAW OF
DIMINISHING.
- LEVEL OF EMPLOYMENT
- EQUILIBIRIUM
LEVEL OF EMPLOYMENT IS DETERMINED BY THE EQUALITY BETWEEN DEMAND AND
SUPPLY.
- DEMAND FOR
LABOUR :- W = MRP = PX MPPP OR W = MONEY WAGES,MPP= MARGINAL PHYSICAL
PRODUCTIVITY. W/P = REAL WAGES RATE
- W/P = MPP . PRODUCER WILL DEMAND LABOUR UP TO THAT
POINT WHERE REAL WAGES OF LABOUR IS THE VALUE OF MARGINAL PHYSICAL PRODUCT
OF LABOR.
- DEMAND FOR
LABOUR IS THE DIMINISHING FUNCTION OF WAGE. IT MEANS WITH RISE IN WAGE
RATE DEMAND FOR LABOUR FALLS AND WITH FALL IN WAGE RATE DEMAND FOR LABOUR
RISES. THUS DEMAND CURVE OF LABOUR SLOPES DOWNWARD FROM LEFT TO RIGHT.
- DEMAND FOR
LABOUR
- D
- LEVEL OF
EMPLOYMENT
- SUPPLY OF
LABOUR :- REFERS TO THE
NUMBER OF LABOURERS WHO ARE WILLING TO WORK AT THE GIVEN REAL WAGE RATE.
THERE IS DIRECT RELATION BETWEEN SUPPLY OF LABOUR AND WAGES. SUPPLY CURVE
SLOPES UPWARD FROM LEFT TO RIGHT. THE AGGREGATE SUPPLY CURVE IS ALSO
DIRECTLY RELATED WITH REAL WAGES RATE AND SLOPES POSITIVE.
- D
- S
- EXPLANATION
OF CLASSICAL THEORY
- MAINLY BASED ON THE FOLLOWING TWO FACTS
- FLEXIBILITY OF
WAGE, INTEREST AND PRICES
- SAY’S LAW OF
MARKETS
- FLEXIBILITY
OF WAGE,INTEREST AND PRICES
- FLEXIBILITY OF
WAGES OR CHANGE IN WAGES
2. REAL WAGES =
MONEY WAGES/PRICE
3. RELATIONSHIP
BETWEEN REAL WAGES AND LEVELS OF EMPLOYMENT IS EXPLAINED WITH THE HELP OF
FOLLOWING EQUATION:-
1.
ND = F( W/P)
( DEMAND FOR LABOUR IS THE DIMINISHING FUNCTION OF REAL WAGE
2.
NS = F ( W/P)
( SUPPLY OF LABOUR IS THE INCREASING FUNCTION OF REAL WAGES )
3.
ND =NS
- PROF. PIGOU HAS
EXPLAINED WITH THE HELP OF THE FOLLOWING EQUATION
- N =QY/W ,
N MEANS LEVEL OF EMPLOYMENT,QY IS THAT PART OF THE NATIONAL INCOME
WHICH IS PAID AS WAGES. W MEANS
MONEY WAGE RATE
- SAY’S MARKETS(
FLEXIBILITY OF RATE OF INTEREST)
- J.B SAY HAS GIVEN A LAW OF MARKETS POPULARLY KNOWN AS SAY’S LAW OF
MARKETS. IT SAYS “ SUPPLY CREATES ITS OWN DEMAND”. AGGREGATE DEMAND WILL
BE EQUAL TO AGGREGATE SUPPLY. BUT IN REALITY AGGREGATE DEMAND WILL FALL
SHORT OF AGGREGATE SUPPLY. BUT CLASSICAL ECONOMISTS HELD THAT EVENT OF
EQUALITY OF SAVING AND INVESTMENTS, THERE WILL BE AGGREGATE DEMAND WILL BE
EQUAL TO AGGREGATE SUPPLY. SO THERE WILL BE EQUILIBRIUM IN THE GOODS
MARKET.
- A ACCORDING TO CLASSICAL ECONOMISTS BOTH INVESTMENT AND SAVING
DEPEND ON THE RATE OF INTEREST. INVESTMENT IS THE INVERSE FUNCTION OF RATE
OF INTEREST.
- I =F(1/R)
- S= F( R) DIRECT FUNCTION OF RATE OF INTEREST.
- S = I
-
-
- FLEXIBILITY OF PRICE LEVEL CHANGES OR EQUILIBRIUM IN MONEY MARKET
- AGGREGATE
DEMAND DEPENDS UPON THE VOLUME OF OUTPUT AND AGGREGATE DEMAND DEPENDS UPON
QUANTITY OF MONEY. AGGREGATE SUPPLY REMAINS FIXED AT FULL EMPLOYMENT LEVEL
AND IT IS PARALLEL TO Y AXIS. QUANTITY THEORY OF MONEY IS EXPRESSED IN
TERMS OF THE FOLLOWING EQUATION:-
- MV = PT , M = SUPPLY OF MONEY, V = VELOCITY OF
MONEY, P= PRICE LEVEL, T = TRADE
- BASED ON
ASSUMPTIONS THAT V AND T REMAINS CONSTANT.
- DISEQUILIBRIUM IN THE ECONOMY CAN BE CORRECTED BY CHANGING AGGREGATE DEMAND OR QUANTITY
OF MONEY, THIS THEORY ASSUMES THAT CHANGE IN THE QUANTITY OF MONEY RESULT
IN CHANGES IN THE PRICE LEVEL. PRICE LEVEL INCREASE WITH INCREASE IN THE QUANTITY OF MONEY AND DECREASE WITH QUANTITY OF MONEY.
- FLEXIBILITY
OF PRICE LEVEL CHANGES OR EQUILIBIRUM IN MONEY MARKET
- MAIN IMPLICATION
- FULL
EMPLOYMENT IS A NORMAL FEATURE OF
CAPITALIST ECONOMY
- EQUILIBRIUM IS
POSSIBLE AT FULL EMPLOYMENT AND GENERAL UNEMPLOYMENT IS NOT POSSIBLE.
- BY REDUCING
MONEY WAGE, REAL WAGE CAN BE REDUCED.
- LAISSEZ FAIR
POLICY BY GOVT
- WAGES SHOULD BE
FLEXIBLE
- BASED ON SAY’S
LAW OF MARKET
- S=I
- PEOPLE SPEND
THEIR ENTIRE INCOME ON CONSUMPTION AND INVESTMENT
- CRITICISM
- SUPPLY CREATES
ITS OWN DEMAND IS
- EMPLOYMENT CAN
NOT BE INCREASED BY GENERAL MONEY WAGE CUT BECAUSE KEYNES IT IS WRONG
- KEYNES ASSERTED
THAT POSSIBILITY OF UNDEREMPLOYMENT
- NO AUTOMATIC ADJUSTMENT
- MONEY IS ALSO
STORE OF VALUE
- SAVING AND
INVESTMENT ARE NOT INTEREST ELASTIC. SAVING IS A FUNCTION OF INCOME WHILE
INVESTMENT IS FUNCTION OF RATE OF INTEREST AND MARGINAL EFFICIENCY OF
CAPITAL. SAVING IS INCOME ELASTIC
- REJECTION OF
LAISSEZ FAIRE POLICY
- IGNORES THE
PROBLEM OF SHORT PERIOD
Thankyou Ma'am
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