It also depends on the extra unit of output that an additional worker can produce if added to the current workforce. 3. According to the Keynesian Theory, full employment is a function of national income; the higher the level of national income the greater the volume of employment and both income and employment are determined by effective demand. But, according to Keynes, if a cut in wage rate causes income to fall proportionately, then the demand for labour curve will shift leftward from YD to Y’D’ and the volume of employment will remain unchanged at ON. 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. Criticisms. 1 Equilibrium level of income and employment is established at a point where AD = AS. Say’s law applies both in a barter economy as well as in a money economy: In a barter economy, Say’s law, which states that supply creates its own demand, is simple truth; it is merely a tautology. Government persuade on the economy is nil. Summary 6. According to Pigou, reduction in money wage, through its downward effect on cost of production and prices, tends to increase employment. Its negative slope indicates that as employment increases, the marginal productivity of labour decreases; thus, more employment is possible only at the reduced wage rate. In fact, the condition of under- employment is more near to reality in a capitalist economy. (iii) Flexible system of prices, interest rates and wages. Keynes pointed out that wages are a double- edged weapon. As a result, the aggregate supply is always at full employment level of output. In modern times, it is practically difficult to reduce money wages for the following reasons: (a) The workers, due to money illusion, often oppose a reduction in money wages. (ix) The circular flow of money continues without any leakages. The employment is found in the labour market in which the employers may refuse to employ the workers. With YD demand for labour (or marginal product) curve, Pigou argues that a reduction in wage rate (from OW to OW1) will lead to increase in employment (from ON to ON1). Sorry, your blog cannot share posts by email. Classical Theory of Income and Employment: The theory is ascribed to early Classical economists like Adam Smith, Ricardo, and Malthus and neo-classical like Marshall, Pigou and Robbins. Hence general over-production is impossible. Say’s law has the following implications: Economic system has build-in-flexibility. Classical theory of employment is based on ‘Say’s Law of market’ which states that ‘supply creates its own demand’. Copyright 10. Keynesian Theory of Income and Employment 1. Thus, saving is investment and not a distinct and separate process. It acts only as a medium of exchange and has no independent role to play. According to the classical economists, the economy normally operates at the level of full employment without inflation in the long period. This implies that supply creates a matching demand for it with the result that the whole of output is sold out. In the Classical theory, the level of (self-)employment is limited only by the supply of labour available at a given real wage, so that ‘non-employment’ is either voluntary or frictional. In such a society, the workers sell their products, and not their labour; the products exchange against products; and thus supply creates its own demand. It also assumes that wages and prices of goods are flexible and the competitive market exists in the economy (laissez – faire economy). Say and other classical economists believed that money acts only as a medium of exchange. Introduction to Keynesian Theory: Keynes was the first to develop a systematic theory of employment in his book. It is by now clear that whatever validity Say’s law has in a barter economy, it has no practical relevance in the modern world as a tool of economic analysis. (iii) It presents a static picture of the world by assuming a state of full employment. Disclaimer 8. For example, (i) In real world situation, an economy often does not function at the level of full employment; rather it generally functions at less than full employment level, (ii) Supply cannot create its … ii. Hence there arises deficiency of aggregate demand. According to Mc Connell, “The very act of producing goods generates an amount of income exactly equal to the value of goods produced. In the modern money economy, on the contrary, the employers are different from the employees. Theory of emplyment 1. Implications 6. Classical Theory of Income and Employment The theory is ascribed to early Classical economists like… Production is more important than consumption. The aggregate demand must in some sense equal the aggregate supply.” In the words of Hansen, “A new productive process, by paying out income to its employed factors, generates demand at the same time that it adds to supply.”, In short, Say’s law of markets maintains that- (a) aggregate demand always equals aggregate supply; (b) every additional supply creates an equivalent amount of additional demand; and (c) there can be no general over-production or general unemployment’. Classical Theory of Income and Employment: The theory is ascribed to early Classical economists like Adam Smith, Ricardo, and Malthus and neo-classical like … The Classical Vs.Keynesian Models of Income and Employment! According to A.H. Hansen, “History of thought illustrates again and again how a great living principle, tossed about on the sea of controversy is likely to lose its vitality. xi. Say formulated a law which is known as the “Say's Law of Market”. 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