classical theory of output and employment

04 dez classical theory of output and employment

It was suggested there that Classical economists can be identified by what theories they hold. On the other hand, with a rise in real wage rate individuals become relatively richer than before, and this induces them to consume more of all commodities (including leisure which is regarded as a normal commodity). Thus, rewriting the aggregate production function we have. Classical economists believed in the Quantity Theory of Money according to which it is the supply of money that determines price level in an economy. Classical Theory of Income and Employment: Aggregate Demand, Money and Prices: Now, we shall examine how full employment of labour is assured in the classical theory even when money is introduced in the system. Second, real wage rate changes quickly to bring about equilibrium between demand for and supply of labour. Thus, in classical theory aggregate supply curve is determined by supply-side factors, namely, preferences of households or individuals regarding work and leisure, the stock of capital (and other factor endow­ments), the state of technology. Keynesian Theory of Employment: Keynes has strongly criticised the classical theory in his book ‘General Theory of Employment, Interest and Money’. With aggregate supply curve AS and aggregate demand curve AD1 price level OP1 is determined. Classical theory of unemployment affirms unemployment The classical economists believed that: (i) An economy as a whole always functions at the level of full employment of resources. The changes in rate of interest would cause investment and supply of saving to become equal. In the absence of saving and investment which we are assuming here, classical economists ruled out the possibility of deficiency of aggregate demand on the basis of Say’s law. It follows from above that the equality between investment and saving, brought about by changes in the rate of interest, would guarantee that aggregate demand for output would be equal to aggregate supply of output. Besides, since in classical theory level of aggregate output is determined by the supply of productive resources, (i.e., capital stock, availability of labour, land etc.) Given wage-price flexibility, there are automatic competitive forces in the economic system that tend to maintain full employment, and make the economy produce output at that level in the long run. 3.5 we have shown aggregate supply curve as a vertical straight line which shows that whatever the price level, aggregate output remains constant. To show this let us assume that the economy produces one homogeneous and divisible good, say corn. However, in the classical full employment model this excess supply of labour (i.e. Further, since quantity of money determines the price level of output, it also affects real wage rate, that is, the ratio of money wages and the price level, or W/P. Further, assuming that the firms which undertake the task of production attempt to maximise profits, they will employ labour until the marginal product of labour is equal to the given real wage rate. If somehow real wage rate in the labour market is higher than this equilibrium wage rate (W/P)0, say it is equal to (W/P)1 then it will be observed from Fig. With velocity of money V, aggregate expenditure on final goods and services will be equal to M1V and corresponding to this aggregate demand curve AD1 has been drawn in Fig. This induces the individual to work more (i.e. Further, it is the wage flexibility (i.e., changes in the wage rate) which ultimately brings about this full-employment situation. Classical economists help in determining the output and employment by stressing more on the role of real factors as opposed to monetary factors. Consider Fig. There is neither excess supply of labour, nor excess demand for labour. To clarify further the restoration of full employment of labour due to quick adjustment of real wage rate let us consider the decrease in demand for Y labour following the fall in aggregate demand for output as it hap­pens when depression or re­cession occurs in the economy. Edit. What is not spent on consumer goods is saved and investment expenditure on capital goods made by businessmen equals this savings. Summary of Keynesian Theory of Employment: Keynesian theory of employment, as developed in the General Theory is outlined in Chart-1. But with increase in money supply, money wages and price level change in such a way that real wage rate in the equilibrium situation remains constant and equilibrium in the labour market is auto­matically restored. 3.6. 1. Hence, given the supply and demand curves, the wage rate W/P is determined. 3.3 (a). Content Guidelines 2. As a result of the competition among the firms to hire labour desired by them, the wage rate would go up to the equilibrium level (W/P)0. Now, with increase in money supply to M2, velocity of money V remaining constant, aggregate expenditure will rise to M2V and aggregate demand curve will shift to the right to AD2 position. Determination of Income and Employment in the Short Run without Saving and Investment: According to the classical theory, the magnitude of national income and employment depends on the aggregate production function and the supply and demand for labour. To produce this good we require two factors of production: (1) Labour which we denote by N and (2) capital which we denote by K. Thus we have the following aggregate production function, In the short run the stock of capital (i.e. The short- run classical theory of income and employment can be explained through the following three stages: 1. Classical Theory of Employment: Definition and Explanation: Classic economics covers a century and a half of economic teaching. Image Guidelines 5. Determination of income and employment in an economy with saving and investment; and. The classical aggregate supply curve is shown in Fig. It was J. M. Keynes who first analyzed the frequent problem of unemployment and fluctuating levels of real output or national income. This belief is based on Say's Law of Market that states, "Supply creates its own demand.” which implies that supply (production) creates a matching demand for it with the result that whole of it is sold out. CHAPTER 5: OUTPUT-EMPLOYMENT THEORIES (CLASSICAL AND KEYNESIAN) 5.1 Classical Theory (A) Introduction: Employment and output analysis at macro level has become an important part of economic theory only during and after the Second World War period. According to classical economists, it is the changes in the rate of interest that brings about equality between saving and investment. He argued that economy's equilibrium level of output and employment may not always correspond to the full employment level of income. As explained just above, marginal product (MP) curve of labour also represents the demand curve of labour (Nd). On the basis of their theory they denied the possibility of the existence of involuntary unemployment in the economy. Now an important thing to know about classical theory is when due to decline in profit expecta­tions of business firms if investment falls as it happens at times of recession or depression how it then explains that demand deficiency problem would not arise and equilibrium will continue to remain at full employment. An early 19th century French Economist, J.B. Say, enunciated the proposition that “supply creates its own demand.” Consider Fig. Further, according to them, rate of interest is determined by supply of savings and demand for investment. The investment demand is stipulated to be decreasing function of the rate of interest . the tendency of the economic systems is to automatically provide full employment 3. In classical theory velocity is assumed to be con­stant. 3.1 A) the excess supply of labour equal to KE0 will emerge at this initial real wage rate W0/P0. Classic editor History Talk (0) Share "The classical neutrality proposition implies that the level of real output will be independent of the quantity of money in the economy. This is the substitution effect. They argued that every rupee saved by households will be invested by businessmen, that is, investment expenditure will be equal to savings done by households. This equilibrium between supply and demand for labour at the real wage rate W/P implies that all those who offer their labour services at this wage rate are in fact employed. The classical aggregate supply curve is shown in Fig. Thus, in classical theory level of employment is determined by labour market equilibrium. At (W/P)0 to repeat, all those who offer their labour services are in fact demanded and employed. At a higher rate of interest i2, the investment demand is less than the intended supply of savings. Now, what is the rational behind the upward-sloping supply curve of labour. It will be seen that ON labour is employed in this equilibrium situation. In general terms at the micro level a production function expresses the maximum amount of output that a firm can produce from any given amounts of factor inputs.” (Snowdon 2005 p. 39), “Classical full employment equilibrium is perfectly compatible with the existence of frictional and voluntary unemployment, but does not admit the possibility of involuntary unemployment. The effect of increase in the quantity of money is graphically shown in Fig. Thus, if a part of income is saved (that is, not spent), supply of output produced would not create sufficient demand for itself. In fact, a part of income might be saved. In fact, output produced consists of consumer goods and capital goods. Classical view that forces or mechanisms exist to restore a position of full employment. The description of the various equations in the model is as follows: 1. The classical theory assumes over the long period the existence of full employment without inflation. Thus, with equal proportionate increase in money wage rate as a result of rise in price level, equilibrium real wage rate and level of employment will remain unaffected. Classical Model of Employment: The classical theory of employment can be summarises in equation model given below: Product Market: 1. //

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