x ¢ What is Classical Theory of Employment? . economy, there are two main theorie: ‘ Ina deena pialissonony. hese eo main theres gag leelonteminon _— income and employment— income anc em cal Theory of Employment_and jan Theory of Employment. inthis chapler, we shall study in detail Classical Theo \ we shall study Keynesian Theory of Employment Classical Theory of Employment has not been the co} ay has becn canstructed on the basis of thoughts of different classical and neo-classical economists regarding ‘employment. The term classical in English language has be S). Asa result, rate of interes will once again rise to OR level. It is therefore evident that changes in the rate of interest will keep the goods market in equilibrium and in a state of full employment. RATE OF INTEREST SAVING \ INVESTMENT Figure 7 #6. Classical Model of Employment Classical model of employment is expressed in the forms of equations as under: (1) ¥ = f(N) Production (Y) is a function (f) of employment (N)] w NS = f[ = a ( P ) E w [Supply of labour (NS) is a direct function (f) of real wage{ 5} w (3) ND =f (F) [Demand for labour (ND) is an inverse function (f) of real wage (3 NS = ND83 ent -treory of EmPlo¥™ ical lassi ket) ° jor in labour m=! il ee =f() ) of rate of interest (r)] ion (f direct function ing is 2 [Savi % jet) inverse function (f) of rate of interest (r)) nt isan [Investme gel | aii in Goods Market) )M LPY or MV = PT or P = {(M) Me aan in money market) equations explain that a . tr ject pti total out (7) dapendis a the lave af employment (\) on ee to classical economists, supply of labourers (NS) depends on (2) Acco are directly related ae forlaboures(ND) also depends on realwages (W/P) butthes (4) Saving (6) depends upon rate of interest 1). There is diect relation (6) Investment (0) depends upon rate of interest (1), The two are inve (6) Money is demanded (M) for transaction (M) are directly related. teal wages (W/P), e are inversely related, between the two, rsely related, Purpose (LPY) only. Price-level (P) and supply of money 1 6.1 Main Implications of Classical Theory of Employment Main implications of classical theory of employment are as follows: (-Fatfemployment is the normal feature of an economy, prea employment means al bbsence of involuntary unem, tion there may exist frictional, volur intary unemployment, etc. ) Equilibrium is possible only under full employment situation, {4General Unemployment is not * Possible but in the short period Partial unemployment may Preval under extraordinary circumstances, ployment. Even in full employment situa- y other alternative theory to replace classical theory he Great Depression of 1930, invalidity of implications of classical theory of often Such as, full employmentis a normal fe Porary duratioMacto Economicy evident. In 1936, J.M. Keynein-hismonumental book, “The General Theory of Employment, In, and Money” not only criticised classical theory of employment but also presented, in its place, a new thet of employment. According to Keynes, “Classical Theory is logically correct, but being based on ree assumptions, it is incapable of finding a solution to the real problems of life.” hoa Classical Theory of Employment has been criticised on the following grounds: (1) Say's Law of Market is Unrealistic: While making scathing, eriicism of Say’s Law Markets that happens to be the main plank of classical theory of employment, Keynes asserted hari ; assumption of this aw that "Supply creates WS own demand” is unrealisic. is because people do nn spend all their income, Tey save a part of i Consequenily, agaregate demand falls short of aageere supply,]n support of Say's Law 6f Matkels, classical economists had argued thatall thatissavedisinvecn Hence, equality between agaregate demand and aggregate supply remains intact. Ho es not necessary that planned saving be equal to planned investment. The reason being that ; economy those who save and those who invest are different people. They have their own motives for saving a _iiwestment. Accordingto Keynes those who save are more influenced by the level of income than by te {eof iniefest. Some people like retirees , who save in order to earn fixed income, would save less ule __Tate of interest is high. Similarly, those who invest their investment decisions are more influenced by expected rate of profit than by rate of interest. To a large extent, investment is autonomous which depend 74h other factors than the rate of interest. It is therefore not necessary that Say's Law of Markets must operate. Contramajo Say's Law of Markets, Keynes was of the view that demand creates its oun rr erin reality, i Saving and Investment are not Interest Elastic: Another dubious assumption of classical fent is that saving and investment are_equalized through the medium of intefest \ccording to Keynes, saving depends on level of income and investment depends on raté of interest and marginal ‘efficiency of capital tis thetetove not necessary that change in the rale OP interest SHGUtd also ing about change in both saving and investment accordingly. In fact, Keynes is of the opinion that saving pee income-elastic. Instead of changing the rate of interest, it is by changing the level of income that {quality between saving and investment can be established. ‘ (3) Criti m of Flexibility of Wages Argument: Keynes has also criticised flexibility of wages argument. According to him it is not empirically possible to reduce the wages beyond particular limit, The reason being (1) Strong trade unions will not let the wages be reduced (2) Minimum Wage Laws can not allow the wages to fall below a minimum limit. (3) Most of the welfare governments in the world do not support the idea of reduction in wage rate. As such its is not possible practically to increase the level o employment by lowering the wage rate beyond a given limit. ) Supply of Labour Not a Direct Function of Real Wages: Keynes has also criticised the arguméat of classical theory of employment that supply of labour is the direct function of real_ wages. In other words, supply of labour depends on real wages. According to Keynes, itis not necessary that wit fl in real wages supply of labour must also fall. Keynes is of the view that money illusion is found amongite labourers. Thus, money wages remaining constant, if price-level increases, of course, real wages will down but it is not necessary that supply of labour must also fall. The reason being that labourers fiave 0 repay their debts and so will not cut down their supply despite fll in their real wages. In other words, th) would not like to remain unemployed. The other reason is’ that the labourers lack bargaining capacity tog their hours of work reduced. Third reason is that policy of trade unions is normally influenced by the= YF 2 9 vom \ Rl aev ef Ws it 1 Treory of Employer % ical ons cin price -level hasa uniform effect on all unions, Assuch, the wel, money wages remaining constant, ge-Cut: Classical Theory of money wage-cut, But this ons. Ris i ise in price-le eto cannot be Increased by General Money Wa, n wages di fallin yi ea ployment unemployment can be removed by general incorree! 0 a pgercit is a double edged sword. It has two aspects: cost a, In fact, ne economists like Pigou gave importance to cost aspect of mon asserted that classical ect. If wages are a part of cost of production of a commodity, its income a as well. Reduction in money wage would result into fall in incoy the woul cause fallin effective demand, Deficiency of effective dema riigate unemployment. During Great Depression (1929-30), as per rather than comists to remove unemployment Bruning and Lavel experiments ical a respectively. Under both these experiments Money wages were Gera ynemploytent but both these experiments met with failure. Instea ployment situation worsened further . ossibility of Under-employment Equilibrium: The conclusion of Employment, that fullemployment isthe normal feature of an economy, and equilibrium is posible only underfulemploymentsituation, isnot valid. Keynes however, claimed thatinvoluntary unemploymentis found in every economy and unemployment could exist even under equilibrium situation, Accordingly, under-employment equilibrium is the normal feature of an economy. Under this situation, unemployment ray existtosome extentorthe other duc to several causeslike, deficiency of effective demand, over saving and over production, etc. . ; 'Y will not oppose ofsister uni policies nd income, Keynes ey wage alone and the same constitute me of the labourers, nd would aggravate the prescription of were conducted in teduced in order to 1d of going down, senor income of ‘This init turn, classi Classical Theory of sence of Automatic Adjustment: Keynes also rejected the assumption of Classical Theor of Employment that there operates self-adjusting mechanism in the economy. Classical economists believed that if due to certain causes unemployment occurs then economic forces automaticaly adjust themselves and restore full employment equilibrium. But according to Keynes economic system is not liable to self-adjusting mechanism. External forces are inevitable for this nines, These external forces are mainly in the form of government interference with the economy. (8) Rejection of Laissez-Faire Policy: According to Lord Keynes, the assumption of classical Theory of Employment, that in a capitalist economy, without any government interference, economic forces themselves will succeed in removing unemployment, is unrealistic. On the basis of the experiences of Great Depression (1930), Keynes rejected laissez-faire policy suggested by classical economists as solution to unemployment. The assumption of classical Theory of Employment that with fall in money wage and rate of interest full employment situation can be restored, is unrealistic. In real life, government interference is most essential to rid of unemployment, In order to remove unemployment government can increase aggregate demand in several ways. By its monetary, fiscal and price policies government can help increase consumption and investment expenditure (C+1) or aggregate demand to facilitate removal of unemployment. ©) tmealidity of Quantity Theory of Money: Quanity Teor of Money which sts that increase in quantity of money invariably leads to increase in price level has also been. eitced Aor ing toKeynes, along with change in quantity of money there can also be change in its velocity. There86 relation between them. If inerease in the despite increase da-quantity of money pri (197 The Clas: studie$ only quantity of money is followed by decrease in its veloci \ jo ce level will not rise, ae sical Theory of Employment deals only with a Special Case:Cl aspecial situation of employment, thats, full employment, Classical e resources remain fully employed in an economy. Hence, full employments the onl is an unrealistic assumption, According to Keynes every economy experience: employment; namely full employment, underemployment and over full emplo (11) It is not based on Empirical Facts: Classical Theory of Employment is not based empirical ‘acts, That is why despite being logical this theory is far {rom reality. Great Depression (1930) hed Prove shat full enyployment was not a normal fealure of a capitalistic economy, as claimed by dace Theory of Employment. Laws of this Theory can not be considered practical. Itcan therefore be sce that this theory is unrealistic and impractical. The assumption of the theory that employment can i increased by money wage-cut is impractical. In real life, trade unions will oppose money wage-cut, oth and nail, It will therefore become impossible to reduce money wage, Another impractical assumption of the classical theory is that by changing interest rate saving and investment can be equalized. In real i, those who save and those who invest are different people. 5 Keynes, while criticising the classical theory of employment remarked that the specific principles conceived by classical economy are not relevant to the present day society we live in. Classical Theory of Employment is an unrealistic and impractical theory. In short, in the words of Prof. Dillard, “The great fault of the classical theory is its irrelevance to conditions in the contemporary capitalistic world.” In the words of Peterson, “The classical theory of employment isno longer widely accepted either bythe public or by academic and business economists, Lord Keynes was of the opinion that Classical Theory of Employment is logically aultles, butits main defect is that it is based on many unrealistic assumptions. QUESTIONS lassical theo, Conommists believed that \y special situation, Butit s diflerent situations of yment.