Classical theory of employment – Economics Studymaterial

Classical Theory of Employment

There was no single theory which could be labeled as classical theory of employment. The classical theory of employment is composed of different views of classical economists on the issue of income and employment in the economy. Adam smith wrote the book “An Enquiry into the Nature and Causes of the Wealth of Nations’ in 1776.

Since the publication of this book, classical theory was developed by David Ricardo, J.S.Mill, J.B.Say and A.C.Pigou. Classical economists assumed that the economy operates at the level of full employment without inflation in the long period. They also assumed that wages and prices of goods were flexible and the competitive market existed in the economy (laissez-faire economy).

Say’s Law of Market

Jean Baptist Say (1767-1832) Say’s law of markets is the core of the classical theory of employment. J.B.Say (1776 – 1832) was a French Economist and an industrialist. He was influenced by the writings of Adam Smith and David Ricardo. J.B. Say enunciated the proposition that “Supply creates its own demand”. Hence there cannot be general over production or the problem of unemployment in the economy.

According to Say, “When goods are produced by firms in the economy, they pay reward to the factors of production. The households after receiving rewards of the factors of production spend the amount on the purchase of goods and services produced by them. Therefore, each product produced in the economy creates demand equal to its value in the market.

In short, this classical theory explains that “A person receives his income from production which is spent on the purchase of goods and services produced by others.

Assumptions of the Say’s law of market The Say’s Law of market is based on the following assumptions:

1. No single buyer or seller of commodity or an input can affect price

2. Full employment.

3. People are motivated by self interest and self – interest determines economic decisions.

4. Th e laissez faire policy is essential for an automatic and self adjusting process of full employment equilibrium. Market forces determine everything right.

5. There will be a perfect competition in labour and product market.

6. There is wage-price flexibility. 7. Money acts only as a medium of exchange.

8. Long – run analysis.

9. There is no possibility for over production or unemployment.

10. Unutilized resources used until reaches full employment.

11. No Government intervention automatic Price adjustment mechanism operated.

12. Interest rate flexibility leads is saving – Investment equality.

Implications of Say’s Law

1. There is no possibility for over production or unemployment.

2. If there exist unutilized resources in the economy, it is profitable to employ them up to the point of full employment. This is true under the condition that factors are willing to accept rewards on a par with their productivity.

3. As automatic price mechanism operates in the economy, there is no need for government intervention. (However, J.M. Keynes emphasized the role of the State)

4. Interest flexibility brings about equality between saving and investment.

5. Money performs only the medium of exchange function in the economy, as people will not hold idle money.

Criticisms of Say’s Law The following are the criticisms against Say’s law:

1. According to Keynes, supply does not create its demand. It is not applicable where demand does not increase as much as production increases.

2. Automatic adjustment process will not remove unemployment. Unemployment can be removed by increase in the rate of investment.

3. Money is not neutral. Individuals hold money for unforeseen contingencies while businessmen keep cash reserve for future activities.

4. Say’s law is based on the proposition that supply creates its own demand and there is no over production. Keynes said that over production is possible.

5. Keynes regards full employment as a special case because there is under – employment in capitalist economies.

6. The need for state intervention arises in the case of general over production and mass unemployment.

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