Classical Theory of Employment (With Explanation)

Read this article to learn about the Classical Theory of Employment!

The term ‘classical’ was used by Keynes who, by it, referred to all economists who were concerned with macroeconomic questions before the publication of J. M. Keynes‘ The General Theory of Employment, Interest and Money’ in 1936.

Modern economists believe that people like A. Smith, D. Ricardo, J. S. Mill, etc., belonged to the classical school of thought while A. Marshall, A. C. Pigou, etc., were the neo-classical stalwarts.

The differences between these two economic thoughts were minor, as far as macro­economics was concerned. That is why Keynes labelled their theory as ‘classical theory’. Here we will follow Keynesian tradition. It is to be kept in mind that much of macroeconomics can be traced to Keynes’ work.

In the classical doctrine, equilibrium level of income is determined by the availability of factors of production. This means that this theory puts emphasis on the supply side for the determination of the equilibrium level of income and thus neglects the supply side.

This supply-oriented classical approach towards income and employment was based on certain assumptions.

These are:

(i) There is always full employment of resources; and

(ii) The economy always remains in the state of equilibrium, thereby ruling out the possibility of existence of general overproduc­tion and general underproduction.

However, the assumption of full employment is based on another fundamental assumption of the classical theory—the assumption of Say’s Law of Market.

Keeping these assumptions in mind, classicists held that a free enterprise capitalist economy always ensures full employment automatically through a mechanism known as wage-price flexibility. At the ruling wage rate, everyone is employed. Actual output equals potential output. There is no overproduction and underproduction.

Say’s Law of Market:

The classical theory of employment is based on the Say’s Law of Market. (This law goes after the name of a French economist J. B. Say.)

The essence of the Say’s Law is: “Supply creates its own demand.”

People sell goods to get other goods (i.e., barter economy and also money economy). Therefore, the supply of one good involves demand for some other goods. Let us assume that there are ‘n’ different commodities whose supplies are S₁, S₂ … S_n.

Likewise, there are demand for such commodities, labelled as d₁, d₂ … d_n. Following Say’s Law, we can say that. It then follows from the Say’s law that the total money value of all its supplied must equal the total money value of all items demanded, i.e., supply of all goods must equal the demand for all goods, i.e.,

S₁, S₂,.. S_n = d₁, d₂ …d_n

If there is an excess supply of any commodity, there must be an excess demand for another commodity. Equation 10.1 says that excess supplies of commodities are matched by excess demands for commodities. Total volume of output does not differ from the level of demand—the act for supplying commodities is simply an act of demanding commodities.

Say argued that the supply of all goods is identically equal to the demand for all goods. If so, there can be no oversupply or undersupply of goods. Every increase in production made possible by increase in the productive capacity or the stock of fixed capital increases demand exactly by the same amount so that a possibility of overproduction is ruled out.

This law thus stands out as a denial of the possibility of underemployment equilibrium. Whenever there are lapses from full employment situation, these are then automatically removed by the working of price mechanism wage-price flexibility.