THE CLASSICAL THEORY OF OUTPUT AND

EMPLOYMENT
 The Classical Postulates

• There is always full employment

• The economy is always in the state of equilibrium
• Money does not matter
 Say’s Law: The Foundation of Classical
Macroeconomics
• Say’s law states that “ supply creates its own demand” or “
supply calls forth its own demand.”

• This law can be explained in the context of both a barter system and a
monetised economy.
 Two Major Conclusions of Say’s Law

1. No general overproduction or underproduction

2. No unemployment under classical system

Classical economists did not rule out the existence of voluntary and
frictional unemployment in the state of full employment.
Classical Theory of Employment: A Formal
Model of Say’s Law
The Classical theory of employment is based on:

1.Aggregate production function, and

2.Labour supply and labour demand functions.
 The Classical Production Function

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 Labour Supply Curve

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 Labour Demand Curve

• Labour demand function can be expressed as:

MRPL = Marginal Revenue Productivity of labour

• In order to derive one needs to derive the MPPL curve.

MPPL= Marginal Physical Productivity of Labour

• A simple and practical method of measuring MPPL is:

 Output and Marginal Productivity of Labour

Derivation of Total Production (TP) and MPPL Curves

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 Derivation of Labour Demand Curve

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 Determination of Employment and Real Output

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 The Collapse of the Classical Economics

• The Great Depression proved that the basic postulates of the classical
economics were fundamentally wrong.
• The industrial economies suffered a prolonged economic depression
and a prolonged state of involuntary unemployment.
• There was supply of capital but there was no sufficient demand for
capital.
• The classical theory could offer neither explanation nor to the problem
of the depression of the 1930s. This marked the collapse of the classical
economics.