Scribd Logo
Upload

Welcome to Scribd!

  • Classical Theory of Employment

    Uploaded by

    simran simie
    21 views16 pages

    Original Title

    classical theory of employment (2)

    Copyright

    © © All Rights Reserved

    Available Formats

    PDF or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Report this Document

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    21 views16 pages

    Classical Theory of Employment

    Uploaded by

    simran simie

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    of 16
    ied Tre noay of economic thougit axetil to such apataas of economists as Ada Stil Ricardo, Mill. Marshall and gow is 700 zee claw eos, Ths me adherents of this line of thinking ine : Lucas, Thomas Sargent, Neil Wallace, R. Barro and B. McCallum. The waditional/elascical theoretic apparatus is based upon the following basic assumptions : (i) There is a state"of=fullyemployment (i) There is (perfectscompetition in the Product and labour markets. (ii) (iv) (») There is'perfect wageeprice Mexibility. (vi) The quantity of money is given. (ii) Moneysactsvonlyvasvaimediumeof 4 yent for other products.” . 3 Given these assumptions, Everett Hagen! observes that the major concern of classical system is with the following problems (i) The determination of the goods and serviees|which are’ tobe produced in the conviction that money exchange. economy. (ii) The allocation of resources competing firms and uses and the allocation of resultant output among the households. Dillard has also emphasised that the classical analysis Sunder the veil of is simply “a study of the alternative uses of a given quantity of employed resources.’ demani ‘ is ion of different commodities, services and of jy. uv" 'S Produced, a part of jt is retained different types of resources, T. EE Hagen ; The Classical Theory of the Le edited by M.G. Mueller (1966). ————— inerementin-supply : ‘market for products. ¢ Supivalvgeccactirumdnmant, opt. Say eam to the concision tt : aggregate demand must equal aggtegate supply. ‘el of Ouiput and Employment rye stration OMNCOME among ive factors: / of Markets oA. theory of employment jg ‘say's La A tap J a La of Mark, based ally refuted the idea of depression Say categorie Py a state of over-production in being cause Te believed that anywact of society. He br e and other ingtm resources. It makes way for the 3 (w) producti equivalent output, Thus an xis. It is on the basis of such In his own words, “The mere circumstance of the creation of one product immediately opens Say’s Law in a Barter Economy ‘The validity of Say’s assertion—supply “ereates its own demand, is beyond any reproo! in a bartar exchange system. Like all other traditional writers, J.B. Say also held a strong merelyafacilitates= ome impact in . Tt may have among the increasing the efficiency of production but it the economic anteway, Thus, Say tore Money to investigate the economic truths related to production tt for self-consumpti tion and the for exchange with the Test is used for 94 qHE CLASSICAL THEORY OF FULL En PLOYMEN 7 in such a way that the aggr insimunity finally getse eq geet in the ther uld be a exhausted tie More-of it Would be rs, quantities of other Renee Tor The given ; uct ued 0 community retains the capabilice et Sbsorbing any increment in prodvaioe wean and the system can indefinitely ma i of full employment. ly maintain itself in a state ‘Say’s Law in a Money Economy Say's Law was obvi context of a barter eee ramed Pathe se ee iisuecnhined, i pets property fined in’ complex economic eee fussing regulat monetary operations ‘The clanicataconomist, for whom Say’s Law of market has remained as an article of faith, are firmly convinced of its validity even in a monetary system because in their opinion, the use of money hardly causes any change in the principles of economic analysis. However, the Law must be evaluated on the basis of the following two principles : (i) The production of commodities and services creates, in the aggregate, a flow of money income equivalent to the cost of production of the commodities and services. (ii) The sre ee ef came unity must be 5 ret Most of the incomes are paid out during the process of production and these are regarded as various elements of cost of production. About profits, however, itis sometimes stated that these are not paid out during the production but are realized at the time when the production process is brought to an end by the sale of products. Thus the flow of income, during the process of production, is likely to fall short of the cost of production by profit. But Hagen the amount of suggests that the income and costs may be equal, if we suppose that the production 35 going at a level rate (neither rising g), with some amount of profits considered satisfactory ant the production has been proceeding © aa of over-lappi where one layel re h is just completed and js about to be = finished, . still anoth a Proce: ler is half-way process of -way through the cot tt we te a ds a on*. Thus, om flow of incomes mu: productivity, whether th biteeeaits CSc deen a St ‘assumi wilt hold urue We must alo make a dstnetion betneen i income sered toa worker or oer as age and income actually paid out to him. The income to a worker will continue to accrue as a produces ‘the goods from day to day and from ur but the amount will go on accruing and the payment will be made, say, after a week or a month, Even if the acerued income is equivalent to the cost of production, the paid out income in any time period will fall short of the cost of production. It is also possible that even the accrued income may not be equal to the cost of production. Let us suppose that the cost of production of additional output is Rs. 80 crores. It includes the amount of profit also fon the finished product. To cover the cost, the Tevenue accrued must be equal to this amount. ‘We suppose further that the cost just before the wife of the finished product, including, profits ratthe suppliers of the intermediate products, is Re. 64 crores. ‘Thus the income accrued [ror the production falls short of the cost of production. Given this situation, when neither the accrued nor the paid out income if equal to the cost of production, the first principle is not satisfied. The American economists, William Foster and Catchings, however, regard this deficiency in Say’s Law as only of a minor and hot of any major consequence. Secondly, the validity of Say's ‘Law in money exchange system must bbe judged from the point, whether it ensures oF not the equality between aggregate demand and aggregate income of between aBerezale expenditure and aggregate income. If the aggregate demand ade up of consumers demand and that government and of entrepreneurs for investments geve‘gnor of te total current INSOT then t uacnO-ECONOMIC ANALY Gig Y f the principle gp instay 0 mainstay egate demand a, a ween ae ‘aw is the theo, oF Sys oa evel in vem sate demand will be less th It ply, eneral price level in an, therefore. the aggregate demand the Boris introduces ini Mituation. a part of the outpat Wi yy a ot er, wen and’ Say or sales ata ¢ conics eof the | st producers «ispose if few ynror ox a te prices uc single quantity of sitet animenes ne Ea, re ix no Unig eat ete ae cee as the cy about WHICH Tess truistic exchange inconsistent mmonmecinent, Ct Fi rting point. I ‘aa ate demand is 4 in Agr may be & BO oad income of the commonity: The MET Ay equation TH) essed as Al aggregate demand equals aggregate INEOME Toy 4 based on the assumption that planne MV =PT a he community investments and savings of th Inthe absve equation. , remain equal to cach other. Py is the er The classical assumption that all income a — = will be spent is, of course, unrealistic, If some MOY s or the am goods receipts will income is not spent, the firms’ receipts will YY NT ices excl decline. The producers will react through a 2% fd. In the above relation, MVsis io Feduction in. output and_ income and specified Pe . The equality consequently employment will also come down, the 3 Icis, however, argued that the savings leakage ERME=E ; may be off-set by an equivalent amount of Saiynig- out taisactions is just equal t0-the, } investment expenditure to be undertaken by the fv other words, it implies that entrepren-eurs. Whatever leaks out of the circular —SUpplyzof money. nount of money, made available flow of income through saving may be poured the entire amount of mor mee aN into the income stream through investment by the monetary abthority, is spent. for. the financed by the financial intermediaries like Purchase of commodities and services or that banks. But savers and investors in the Mole acts only as a medium of exchange and community generally belong to separate groups, {here.15 no rational ground for holding money there is no reason to suppose that the amount 38 @ passive’ balance. Whatever is the amount of saving will be perfectly matched by “of moncy supplied, it is matched by the goods, equivalent investment in different production Nd services of an equivalent value, Thus MV periods. The classical answer to this objection Temains equal to the aggregate spending of the lies in the role of the rate of interest as an Community and PT is th . } in the y is the total value of output, equiliberating mechanism, The equality between MV and PT, obvious! The rate of interest in the classical theory ig '4ieates that there is. p sistency and the nexus that links the decisions to abstain from | C™Plementarity betwe present consumption and the decisions related Guan theory of mon to investment. They assume that bi * Supply of ; and investment functions cetaceans? diferent tom the ae id Tone tiene S=f(r) “Ppropriate changes j T=f() Prices will restore. e The variations in the rate of set in motion an adjustment proc interest wil) Of T and V a ess between My additional 3 least in the sh the ex-ante savings and inve i alamo © stort period, equilibrium is achieved wher estmeMt The PHCE Level ina ginee™ OF Money will raise the become equal to ex-ante investment and @n8> yh WOuld have (hon PFOPortionate manner. it the equality between aggregate one oush Pelance between ye’ “Het of restori he and aggregate income is restored, Petre HAS of the gor, AMount of money in the . Value of munity ' S@ =1(7) that the t0tal ourpur Ty cbending and the al ¢ assumptions Of money ig Motiv held only for auandithatithatiscas act ‘hanged with money during a i THE ( price If we redu pric cons law and exc JHE CLASSICAL THEORY oF FULL EMPL OYMENT es are flexible make the Says law perfectly consi If we drop the assimptio, reduction in the quantity prices will cause une! consequent low off-take law, in such a situation, and the supply will have excess of the demand, Right from 1942, th controversy about the consistency of Sasi een with the quantity theory of money, Don Patinkin is of a firm belicf that these two are am ist a wwith each other and any model, which includes both of them, commits a grave logical error, Patinkin has pointed out that Say’s Law is based on the proposition that goods are produced with a view to exchange them for other goods. The 1 quantity theos stent with each eitee ” of flexible prices, of money with rigid mployment anda Of the goods. Say's will become invalid a tendency to be in in exchange, motivate production. In other words, the implication is that the supply of and demand for each real goods depend only on the relative value—what each commodity can buy of another commodity. But if all the of as constituting a demand schedule for money. tes the supply schedule of money good constitu ble relative price for each good, ‘At each possi good, an excess dem exact balance betwee! relative price, ther money, a net demand for money, relative prices there would be nm two. and net supply schedu net demand schedule fo the demand and supply sched! or at certai We can now aggregal es to get one ag; rr money. In this sens h depends rices. The ly inconsistent for money whic! but on the absolute P' schedules are obvious other. However, money has no ul n itself. It has to facilitate the ina act as the medium of exchange- q Ss ‘The demand schedule, in the same way, for each there would either be an excess supply of the ‘and for the good, or an vn the two. Thus at each e would be a net supply of either of the te these net demand gregate jules for each These two demand with each tility:in. and of antity Of money and the veloc 7” money suggest the absolut Prevail Says nw. nen hy isl con ‘any absolute price level. And x0 long ne every economic agent has a minimum balanee efsbe terete ee he assumptions underlying, Say's Law and th quantity theory of money. Im this way, Says Iaw and the quantity theory are perfectl consisjent and complementary. * Y of iron o ie level tat wh 9.3/ Determination of the Employment and Output ____As pointed out earlier, the classical the is the theory of full employment. It outlines & model which ensures the maintenance of equilibrium at full employment. of aggregate output and employ-_ Level of quantities of other goods, that can be received-—mentyacording to this theory, ae. delsrmined — snd the ‘The mm, given a fixed stock of capital and technology in the short period, postulates a positive relationship transactions are to pass through money, the 5, + tween output and employment. A higher supply schedule for each goods can be thought” jgyel of output is associated with a higher level of employment and vice-versa. where Q ae e evel of ouput. N is the evel of employment and K and T represent the g respectively. The demand functi from the aggregate production functi depends upon the labour inpu in ion of labour is derived es ‘thas been shown in table 9.1 Pec i te net demand apes commodity as well as the agereza : for ney, depend simply upon the Tela etn Tale cnering OS ices and are quite independent of the absolute etna Product of Labost Pees. ‘The quantity theory of money, on te enor hand, puts forth a second demand schedule ; not on the relative and jon which Employment yacn0-SCONOHOTAE HE CLASS 7 t fen re cvemployers, singly | evel of er oe nore in proportion sy eortere of ork Gjuenty. the employer, ie tinemploy 3s. Consedes in order (0 hire to be a equilibrium is determ) through t so TM full employment level Nyy the wag ye there is an unemploy employn wage Tyhich tends t© be wiped ge | unchang ° system t a s the workers wetition among. th Re fof tab nisation it-mavimiss jor toes ten unshes with ; ty Fe and the real WaEE ‘may be pointed out = wir that work involves strain. exertion and sacrifice [jemure. This makes additional work-load or we 2 large number of labour-hours quite Ps disagreeable to the workers and is generally eee the marginal disutility of labour. (WP Unless this disutility of work is neutralised through the payments of additional real wages, the workers cannot be induced to put in additional labour input. Thus the-supply of _labour-hours_is related positively to the real Fig. 9.1 wages of the workers. ideenati oy - jobs and the equilibrium at (W/P)p wage rate is 5. = WP) finally determined at No full employment level. | Given the demand and supply functions of At a lower real wa; is an detour tit : possible to determine the Over-employment a euitlear a ie By which : fend tee Ms employment, when the denotes a state of excess demand for ‘about of lbour athe equbium real moses gape Bush up the wage rate and tend itt jp. I the real wage rae (WP) is Meher fae Tee CP, 2 ll poate 1 is higher than ‘librium 1, is eum ‘ate, the Ibour supply will be ire aulibrium level of employment N demand for about, denoting a TCPTCSEMS @ state of full employment. It is opportuniti lecline of reduce the ui OF real w be a tendency roars 82 and the m lency towards the achien consistent with the a8e Fate which is perfectly : e margi 4 certain numbe; Marginal product of labour; T of workers are not willing © t0 work, it wi it wil do not offer thes ae Mean th equilibrium at full emplo wage, on the other hay THE CLASSICAL THEORY OF FULL exgp LOYMENT level of employment existing in the og denotes ‘full employme; 1© econom, 80 nt oF th “The funato workers. In the classieat Sy S™Movable ane yi, felons relationships involved ip unemployment and oversemployung tot" tHe and naesreekst HNN sytem wont to be automatically adjuniege ee EP end re given helo through the adjustincnt mechanige Qf KT the wage-flexibility. Any lapse trom full Dy, = sewn employment, assuming the price level ye he Sh = fw) unchanged pasa be easily overcame in the Mv ang system through the variations in ware sq 4 sys N Wage rates The classical system of full employment 9.4, (Classical SyStEnv without Saving ang Sibriui not iwvotving the eee Investment” investment has been shown in Fig. 9.2 which isa at \ i the r—Stice the quantity theory relation variables in labour market. goods-marketasd hholds all along the curve. tt relates the ives the the level ut and price, Given-the-level ich indicates which remains constant by different Tevels Of output at different inpus.of assumption) there om a f production. {ind level Po, Part (i) of the figure represents the jue of production {OBE given in the short price-wage adjustments, (WIP) represent the Sion "Te demand for and sopahy oP state uiibriumerel wagestive which isthe iocws in the labour market determine the equilibrium of different money wage rates and price levels Jevel of employment, which in the classical such that the real wage rate aa ba system, always coincides with the state of full _ the same. Given this equilibrium real wage is, »mployment. The»money-market explains the and the equilibrium price Po, there is only i rma |. The money wage rate Wo consistent with the both. _ Part (i) of the figure ‘shows the_ production quite independent of the Tevels of fabour inputs Function which relates the Tevel of output _BE ISTE TNE A THT and output. : a Xn ow a= tN, wip OL =f(wiP) (wiPio 100 of capital and techniques of production i assumed to be given, The production (unelh indicates that the level of output Qo corresponds With the level of emplayment No, Patt i of the figure shows that the demand function of labour along with labour supply functor determines the equilibrium in the labour market at No full employment level with the equilibriunt eal wage rate at (W/P)p A better understanding of the classical model can be had by analysing the effects of changes in several parameters upon (he equilibrium values of the variables. Here we shall analyse the effects of a shift in the production function, a shift in the supply function of labour and a shift in the money supply functign~ () Shift in the Production Function : An increase in capital stock or an improvement in production technique over a long period can cause a shift in the production function in the upward direction (Fig. 9.3.) The new production function will involve a rise in the average and marginal products of labour, so that there will be a new marginal product curve or the demand function for labour at a level higher than the original demand curve for labour. Qi ECONOMIC ANAL! SID in the labour rapetition among the comprensified and they © Jo ane workers. Thus BC WO rise from No to to Q; and the ti money Market can be cleared Me output by a fall in ty function of gst remain equal [0 from Qo to Qt decrease in such that rv. Since MY "nerease in output jme, involve Po to Pa Given the (wiP),, despite a to P, the money Wag Wo to Wy. This analysi important implications : 1 ‘ (a) A shift/in the production function caused by the increase in capital stock and cat gical improvernents, unless off-set by the growth of population in the long Tn. will teeure an increase in the level of employment. (6) ‘There is an increase in money wage and consequent rise in real wage, given a fall in THE CLASSICAL THEORY OF pip EMPLoYMeny er i rice level. It signifies an improg, i ges 5 I sans PeoneoveMENt in the ssuming the supply of : ONEY to Jr Output will ines ‘clin the economic (i) Shift in the Labour Sy, ria would be unemployment at the constant leas of foal SaKe. Thus the equiliiun vant Feel will go down as aq Consequence of the competition among the workers in acy" employment. The workers may yo willing to 'y Wages. "The work even at the lower mone impact of an increase in the labour supply function can be summarised as a lower eat wage, a larger employment, : price level and a low: in Fig. 9.4, Given the labour demand function Dy, the equilibrium is initially set at No level of employment and (W/P)q real wage rate. As the supply of labour increases, the supply function shifts from S, to S,j and the level of employ- ment expands upto Nj and the real wage rate falls to (W/P).. At (W/P)p real wage rate, the unemployment gap can be measured by the horizontal distance between Dy and Si). This will create a state of competition among the Q workers to the real way System tia the redwetig secure Re From rom No to Ny, ie lew Uneteases trom Qoto'g,. N® Ive of outpt Given the uniform unitary el: OFM unitary elastic money con og UNetion MV. the ‘price "ene Correspondi 10 Qo level of Output is Po. As the output increases to Qu. given the relation = PO, the increased Output can be cleared From the market only through 9 redecien Price level from Po to Py As the real way ge declines, consequent upon an increase in th 1¢ supply of labour, the real ‘wage function shifts to the right from (W/P)y to (W/P),, Tt indicates that the money wage corresponding to Po level of prices was initially Wo but at Pi price level the money wage has gone down to Wy. We find here the decline in the price level is relatively tess than the fall in money wage, so that the wage decline provides an incentive for the employers to provide more Job opportunities and, despite a constant supply of money, it becomes possible for them to clear the additional output of the market. 102 The implication of this analysis is tha’ the Wageprice flexibility is such an automatic adjustment mechanism that enables the systen {© remove the traces of unemployment and achieve full employment without involving any Overt interference by the state in economic setivity. The classical writers asserted that a decline in money wages and prices will ensure higher levels of employment and output. (iii) Shift in Money Supply Function + Tf there is an increase in the moncy supply function. the classical system will permit simply an increase in price level and money wages. The level of output, employment and real wage. iwill remain unaltered, Assuming that no part “Of the additional money supply is held by the community as a passive balance, an increase in money supply will raise the value of the “totaloutput to such an ‘extent that the di :mand for and the supply of money remain in a sta Of equilibrium. “As the increased money supply fails to raise the supply of goods and services, the additional supply of money will be absorbed through a proportional rise in prices! Now if the price level rises as a consequence of increased money supply but the money wages are not permitted to increase, the real wage rate will depreciate creating a state of excess demand for labour. The pressure of competition among the employers to retain their workers in MACRO-ECONOWIC. their existing employment and ¢ movement to other firms tend, money wages up. The increase in mon however, must be large enough "tg the excess demand in labour maytag objective ean be achieved only yp! My money wages are raised inthe same pe? as the increase in price level, so tht ty wage rate remains unchanged and ther es effect ofthe inereased money supply yao level of output and employment. i Fig. 9.5 shows that the equilibrium yy labour market is originally at (W/P) realy rate with the level of employment at Ny, Gilt the production function Q = f (N, K.'t) level of output corresponding to Nos Qp ¢ the money supply function, the price | corresponding to Qo output is Po. As the moy supply function shifts to M,V, given the sy of output, price level rises to P). This in in price level from Po to Py brings about equivalent increase in money wages from Wy to Wy. The excess demand gap (RL) in ty labour market that could have possibly bees caused by rigid money wages Wo, stand completely wiped out. Thus the equilibrivm Position in the labour market remains unaffected and further increase in employment occurs a (W/P)y wage rate. Consequenily, the level of output also does remain the same. i LY, Is to, i | af SICAL THE THE GLASS CAN THSORY(CRIFULL EMPLOYMENT The main implication of th the classical system involy, penween the real and mone increase in quantity of money changes in the monetary sector of thee through variations in the price level ie conditions in the goods and factor mavkete rem quite unaffected and the levels of employment dnd output do not undergo any change nt 9.5. Money Wage Rigidity and Employment ‘The classical theoretical framework is based upon the assumption that there are perfectly competitive conditions in the goods and the Tabour markets. It also presumes a downward wage flexibility, which clears any excess supply in the labour market. The decline in wages will reduce and eliminate whatever unemployment exists in the economy. Let us now drop these gssumptions of perfect competition and wage flexibility and hold that there are imperfections in the labour market because of the downward rigidity and upward flexibility of wages. Such 2 situation might result because of a number of factors. Firstly, the workers’ organisations may refuse to permit any reduction in money wages when unemployment appears. Secondly, the labour organisations may exert pressure upon is analysis is that cs a dichotomy HarY Sectors. An Causes significant ‘conomy Q as 103 OFS 10 rai Nets 9 raise the money wages even the empl though there is ‘no excess of demand) trowel dl over su TrshaUt Thirdly, sucha situation might teat Wage a focal customs, legislations. andthe Inga aalictes of the government, Fourthly, it Tet be om account oF the liberal attitude of semblozers towards workers and greater 88 on their part 10 co er wiltngnens on part to concede high Given these factors, the money wages in the economic system will be rigid in the downward direction but quite exible in the upward direction. Thus when the excess supply of labour exists, the wages will stay rigid. However, cven slight excess demand conditions, will push money wages in the upward direction. We are to investigate here the effect of such a situation upon employment, output, real wages and the price level (Fig. 9.6.). Initially the equilibrium is at No full ‘employment level where (W/P)gis the real wage rate and output is Qo. If the money wages are raised to Wy so that real wage rate is (W/P),. the level of employment is Ny and the excess supply of labour exists to the extent of RL. At Nj lower level of employment the output is Qr- Given the money supply function MV, a decline toa in output from Qy to Qy will involve some inetease in prices from Py to Py. The rise 1 Price level is essential for if the price level Femains unchanged, the real wage rate will inetease all the more and the employers Will Produce less and provide employment 10 sti fewer workers, A smaller output with na increase in prices ig quite inconsistent with the give Supply of money. ‘The inerease in prices would be less than proportionate to an increase iM Money wages for, ifthe prices increased in the Mme proportion as the money wages, the real ge rate would remain unchanged and the employers would like to produce as before. But it would again be quite inconsistent the employers would sell the same quantity at a higher price, even though the supply of money remained unchanged. ‘Thus the wage-rigidity in the downward direction implies an cquilibrium of economic system with unemployment, This drives home the fact how significant is the assumption of wage-price downward flexibility in the classical full employment system. The wage rigidity completely shatters the classical theoretical structure of full employment. The implication may also be derived that the classical system can not be regarded as unsound, illogical and incomplete, as alleged by Keynes and his followers. It is only through the introduction of a more realistic situation of downward rigidity of money wages that Keynes approached the conclusion that the under-employment equilibrium and not the full employment equilibrium was a normal feature of the capitalist economic order. The same conclusions can be derived even from the classical theoretical framework as shown in Fig. 9.6. 9.6. Classical System with Saving and Investment The classical analysis so far has been pursued on the assumption that the community spends away its entire earnings by way of consumption and no part of it is saved. Saving is one possible trouble: spot in the otherwise harmonious picture of classical system as it can explode Say’s Law. Even when they recognised the existence of saving, they interpreted saying ‘as an alternative way of spending on capital goods. In their scheme of analysis, all saving is automatically transformed into investment spending. In this sense, any amount of saving uncRo-ECONOMIC ANALY e use any aericiency i” ABBegu 1 is unlikely © eg i a endin8 « strategic classical notio w sree basis of th ani of the rate gt < is the equilibrat stipposcd to transform savings r imterest, which ST jmount of investment, The ; into an cauivanen’ gstulates, both saving and classical SySt6™ nctions of the rate of interest, | investment 88 (Oe nen direct function of the Sings assumed nent 8 the vere rate of interest a) re ving and investment | function of it aft toto equilibrium by the can be DIOURN Gp interest. Thus im the variations in classical sys! . following relations = i § =f (9 (Saving function) + (n investment function) | 1 equilibrium in the capital market) ® another significant fact in connection with | the above relations is that saving and investment) i rea we must introduce the ire Supposed to be relatively more interest: aesti¢ so that the volumes of saving and investment change with very small changes in) the rate of interest. | An excess of S over I ean be offset through | a reduction in the rate of interest. On the | opposite, arise in the rate of interest can restore | equality between them, when investment | exceeds saving. The possibility of transforming — any level of saving into equivalent volume of | investment through small variations in the rate | of interest is based on the implicit assumption | that there are infinite possibilities of new —/ investment in the economy because, otherwise, | the excess of full employment saving over | investment will vitiate Say’s Law and permit the economic system to degenerate into secular stagnation, _ The classical full employment system with saving and investment can be studied through the following set of equations ; " Q= FOE, T o D. = sow) -Aii) S. = sown) it) ay MV = PQ of) S= f(y solv) fi = f(r) ov) Ss eu(vii) ey the basis of equations (i) to (iv), we 'y analysed the classical system THE CLASSICAL THEORY OF F LL EM carlicr (without savin, cater coon S308 sn nveumeny, yee Min which incorporates saving Mt Mere (oO ip with rate oe TE AM invest sets have o be studied quite rent Tygetinent ae et oun the rate or ntebende, ff ivision of Output between Meese sh SGasumption and investment pee" fe independent of the factors’ ctors stment i aly oy od set OF ms to 97, Monet size of national output, fuene lary an PUL quantity of mons the Syatenn 2 8M! Fiscal Poticles in Clana Classen dhe level of wages. and ‘prices. ht 7 impact of S-1 inequal ae Hower) in The nove disc ict ge ede ee eee a volume iavtnt cae of ane eoiss Of Saving ovine meat 3,8 lsat water une acs canet ver In spiel wtiters, vas the wage neni fall employment ex-ante § exceene ea, th roe tft Beet thatthe et ], it means that expenditur rea the ex-ante ‘nd automatic coments Provide ction in eon a corn ca complete jlus investment goods fs CONS Me eOnomic syste ive mechanism ph al output. GIVER, he erent sumption Wt seems sytem towards fll arin ean he of ‘surplus output can be cleared tro eee Ey i adenine as matter of pact at lower prices. The fall in price ote te market level of money wages, ne Sileument on will pach ase it may cause wage-price i up the teal wage rate as: price instability 3s nec yin the ec sining the weeny tena fr wage ii [i iceman ue uBges t0 be given. The increase i toa grea rate will cause an e7 ease in real wi 2 great extent by preventin, sa Whe demand ees ofthe supply of ee ines interfering. with the savings over ployment will lower the level of omput elimination of fractional tse through the i giso. The interest rate Fae Goatees en paso trial mses] ayaa motion the process of sahusieent set into central: bank ee motes il ruc savings, re A fal in seon of he uennerea beak If he Soxk an inerease in_ consumption So ee ee inatbed nope a Sift Wang an eament expenditure will also increase. Gi tn inset proeats we pene srvesipply of money, an increase in ags Given ae inrest wl he eerae acta MM enditure will raise the demand for iy equilibraing mech a i necessity open will push up the prices resulting eine serial SE eet white in real wages and a consequent oF fs nthe SPD on decling dhe excess supply gap inthe labour caused by anges ne teen obec market. ‘Thus a reduction in the rate of interest, determinants of money velocity, neon sea initiating tendency towards equilibrium in controlled variations in the stock of money. the capital market, sets such forces into action The intelligent regulation of monetary policy which tend the labour market also towards will help in the ‘avoidance of inflation and deflation and will, at the same time, ensure the cquilibrium at full employment. Excess of Investment over Saving : An maintenance of equilibrium at ful employment excess of ex-ante I over S at the prevailing rate Hess that the only ‘The diverse monetary instramenss be of interest will imply an excess of ex-ante employed for exercising propet regulations on expenditure over the value of current output the money supply: bie ‘example, 8 rise ae As i i 3 exame Tam reser This will precipitate an increase in the price commercial ‘banks’ mini c level. vine real wage rate will g0 down and requiremen’ vit Tre hb : i ir loans and cre it operations. They \ \ Pe ortfolio and will 5 demand it pe crate a state oF be choked off the sAle of securities from porto! market. That would ultimately : bya wise in the rate of interest, setting 4 ot bi rela sa ie ane rc Tas ae ea 20d ea reserve requirements will increase the soppy with the general lic. This market. Thus the interest rate flexibility ensue? a state of full employment in ec use money ects them instrament of monetary policy a Tanking supply inthe same way a me 6 Pofiey of pen mathe PETA cap AS apaunet the monctary pOwieys SO policy” requires the direct 1M oH Bovernment through alterations in_public €8f and character of taxation Toan operations. The fiscal Meares Ary relatively. more direct than the nie mioasuires, he latter affect the coon activity through variation inte a at a SHhtse atau em 2 particular manner. Bot despite the dselmess of fiscal policy, Gardner Ackley opines that fiscal policy was seen to have no place i the anscnal of stabilisation measures except a might incidentally serve as an appendage monetary policy If we suppose that there is unemployment as a result of an increased propensity 10 save, the commercial banks" sale of securities might have no significant effect and necessitate a reduction in money wages. But it may also be difficult to secure a wage decline. Under such circumstances, the need may be stressed for increased government spending for the creation of jobs. If this new spending is financed by additional taxation or the sale of bonds, the net effect may not be favourable, since the increase in public spending is at the expense of private spending. But if the public expenditure is financed by the creation of new money, there will be a net increase in demand. The exactly similar effect can, however, be achieved through the central bank’s conventional policy of open market purchase of bonds. Commenting upon the public works policy as early as 1925, R.G. Hawtrey had remarked that proposal could have been worthwhile, if that were financed by the creation of credit by the banks. But the creation of credit itself, unaccompanied by any expenditure on public works, could be equally effective in the provision of new employment. Thus in the classical enunciation of economic policies, the public works are the mere rituals and’ are expedient only for the politicians to say that they are doing some thing which actualy is quite irrelevant. “To resort for the purpose (of creating employment) to the construction of expensive public works,” say Hawtrey, "ig tg date mates 0 a \O-ECONOMIC ANALY, wace | pose For He SAKE OF tHe oy aire owe He change ali tn ee n policy reigned supreme y 1 malty ee ine = 1930" Wits are fully recopnieg suggest mn ary pay wn pentane’ OF Te ‘modern economy that the dle yet rang. towards the fey, ahified king a ee rom stabilisation, | Soe hin as a means ih, fone ee * atinek on the Classical Theory concn 98 Keynes ic and political developmen, sen ‘The economee Fe *20th century pushedthe an in the first hall OF alysis and policy On the wie system Of “he eventual collapse was, Eo brink OF Pee ie by the blistering attack that Theat however, ox against the classical ideas in oop Keyes Ih a st Reybesio prep his General TheoO™ the classical theory. and aa econcmists alla casei s policy on the following 2! { ‘ u i) Reduction in money wages Is an vos @ Reduction’ Muce real wages : Keynes’ inexpedient way Tas been directed ia a ion classical theory has be te the 1 fhe classical contention he first instance on ; i that the level of employment and real wages ant lcrmined by the intersection of the demand es are e 4 and supply functions of labour. In this i connection, he makes two points. Firstly, he | i denies that the supply of labour is a function | ; of real wages Ii unlikely that the workers 4 d will withdraw themselves from the labour market e hen-their real wages decline on account of a | se in| level of money in the price level, though the level of money } “wages remains constant... ; “He vehemently refuted the classical notion that the workers can determine the real wage and with it the volume of employment through money wage bargains that they make with the employers. It implies that the workers. will voluntarily negotiate for lower money wages with the employers. It sounds quite absurd in the present context, when the organised trade unron action is directed to ensure the stability of money wages. Moreover, money wages gannot move independently of the price level. , i ea it snaximisation Principle dictates that { 's adjust their level of Output at a point n where marginal revenue beco r lone} woul, Cause a " 0) and it is Proportionat THE cl LASSICAL THEORY OFF ULL change along with a C TF DeTistees ay Nahe Move coeeestng a Mex “ Fees BAERS Dilley. the a ths te su nly presoccay cvs en" hifted to the Fight ction cated with geal Wiity, EMS wn 107 Seed Tes Taek the ey Kha he tack jgp ft? t= bree dow | Eilon eat ha y com Inte hiner ot at ths BRtCRAIE mene Meret effects Keynen pene ‘p2BECR Ate deme eee Keynes 9 sive fai AL leat ave faith andy acne ann a B.a reduction wae in the rate af eerste consequently, there might ht no Cierest went generation of © et here anight not be any ft Seok also BE ruled gue Ue ny tnther te may be greatly See THe possititity erate impact up mone: hat un possibility Re Fate of inn He Ine snvestin ley, Wages, by leMploymer he int Of interest is, - mt red tery sonia vety large th Thee mployiem function A clans ond en large propor es funcon: Ata low tea inet pee WAL aon rate meres eee rest. the increinse Income of the © communi unity garegate SABE ines ‘ seabs, incomes ropensity’ of thy decling ances igpensity 10 consume amogg it Teton Nara wail ene a ong also the Recessary that fate of terete very seat jalume of investment sil en il fe relatively much hi th h eWay Se ae Weavage-emers Inceas: wa ery Sy Rea! dolce Rarer a det nares ae hve positon waa defended We Bigs aan pte ein hn it ends topiee o elastic, The lative =a. aos age ahat ie calledjan te vig classical itvestment functis ee thropet Balance Effect. the Pigou Elect o iindstanee inthe onperal pose» eaiee the other classical cl Plggu Goran teen, | Moteever, th the expansion of investment mero ect. Pigou departed from More he te a eae ies ibalancecetfectsccutienmeer, ‘ep over, he eee of neces inven employment, Other writers, f Se aE Nae sao upon Toone ead employe cmployegument, pointed following Keynesian Sastoa tase te oaqntete ch we I ‘gument, pointed Keynesian ™ultipl we magnitud is He oe erages ol inted out ee mls Only if the ep investment in money ng demand for mo ut that a reduction eran of we a hive 9 Bese Mars balances. fone) and supplement a ee ean the as ohich,in {urn wil Tower the rae sna eens economic policies + K OF pe of investment and empl Induces gat Samant pies bo. te sic ma troduced into discussion @ Hy eee oes ee case shen ace ‘ew variable—the ployment, classical wr cash balances. Accordit the advocated a flexible w et the declining wages and prices wi roe sored acy supp. Ke policy coupled si the real value of the monetary iat Be clea Sm ony fae see Community. This will cause eae cane eines pease community: “pe amount of Svitl aug wncerainy ee castbilty which will pechaps reer strengthening oF ae ot render al economic calculations completely resulta ian hich 8) tL ae ttle, on, Classical insistence UPOD arecilirium at full employers But even te a a money Sa a te el balance afl em oul vai eens ia “Feynes ‘ ee criticism has b ted against it argued hat a more realistic policy should be yy Keynes, Patinkin, Samuelson and Korihara an admixture ‘of stable money wages and The downward wage-price flexibility will gradually rising supply of money. THe stable generate an adverse expection: the stability of \ investors t0 expenditure. e expectations the mounting debt burden SF i yt a reduction in veal wages: ye the conceded that the "Pigo? C jortance I the face of : Money wages, will ensuke will force both the consumers 2 i sure, Moreover, the one hand, will create favourabl ‘ benefit which ma} yossil ye from bring ‘abot rc Mf the er EN Pigow himself real ‘wages are reduced. treough 2 reduction in es, itis likely '© provak and of little practical imp‘ © will resist the ‘A gradually rising FI joe level, O° postpone their plans of expenditu iI} neutralise any among cnirepreneurs. 2 sn the other Hand, the real balance effect. Even s ah ‘Pi fect’ would be ‘fight money WEES ie re om the WorKErS: ‘They THE CLA Moreov' Fnerest of ex weil ten to fall equilib there emplo: very pss aly the cota In eising pri te +5 =O ly GS-6 Sah “f° denotes the magni, tive demand For jor subsrit fener, he MOBMLudy seulative demane A variables 4 aw pointed out s misputed the AbOVE Contention ect of spec! nes di inti ical theory W lect of alysis Key! rear writers by pointing out thay 4! d for money. The convent urpose ihe classices Tr yestment decisions in. ft presumed that moaey was held forte rolding saving and ae icity tivo fundamentally of conducting transactions only qn be quite Community ane of people. It is quite absurd ¢ ot passive balances was consuered 10 PE JUNE communes investment will be made g(® cared, These ee anal person havi9€ ggzume that the investment ST" be made cash baleece eheldeice preference 10 thE rate equivalen od that interest rate flenibitiyy fash betances should pve reece eee Wehaniam which brings saving holding of certain return-y ered Provides a m vilibrium. ‘The hare consi than idle cash balances. ‘Thus they com into eq n 1 Fee ee anny LO ee ed invesun the decisions of saving and investy tw 5 hey attached wut by the variations ; 8 quite irrational, As a result 1 brought abo in importance to the fact that money was held groups is oremst and, in the process, ex-ante simply as a medium of exchange. On the be the rate o' aan ‘employment become, equa of this significant assumption, the classical and I at ed this logic of the clase writers defended the validity of Say’s Law in Keynes has attac) round that the convent} the money exchange system. But Keynes firstly, on ale assume that investeay founter-argued that the classical reasoning W@S ‘yriters implicit i fallacious because, at a low rate of interest $8¥ opportunities are iiteslond He possible a : about 2%, the interest-earnings from the owning QPPOn En on by, of assets may be very small. The entrepreneurs |o\vering the rate of interest that the over-saving gap at full employment is wiped out. Secondly, have to weigh these interest yields against the d GApital losses which might occur, i the rate of fe" disagrees with the fundamental lassie interest rises from that minimum level. In such assumption that S and I functions aré both a situation, the entrepreneurs may consider it~ interestelastic. Keynes emphasised that the Eortiwtite 0 oe oe al eat investment decisions are essentially determined i eink ay eka them ichaga eune by the level and rate of change of anticipated balances becomes perfectly inteestelastic and Ome. The cost of borrowing may be onl the considerations but it is only of very minor | money becomes perfect substitute for the i : securities. In such a situation, whatever amount ™POrtance, During Prepeetity, when the Of new money is issued by the monetary fi Pam authority, the speculators continue to absorb ix T#l€ Of interest is unlikely to have any arresting —_| {o satisfy their infinite demand for passive i™Pact upon investment, Similarly during pavances. This state, known asthe liquidity rap, 4€Ptession, despite Nery low rate of interest, has very grave implications for the ful] 9 investment may be forthcoming. In respect employment equilibrium and thoroughly of saving too, the decisions to save at higher rarnaa gt classical system of analysis, In Yel of income a Quite independent of the addition, it poses @ grave dilemma for the changes in the rate of interest Thus, according monetary authority since it renders monetary ' Keynes he saving and in nt functions policy altogether ineffective, are relatively lege = vesrment function 2 eh ; interest <

    You might also like