Theory of Employment

Classical theory of employment

The classical economists did not formulate any specific theory of employment. They only laid down certain postulates: The assumption of full employment of labour and other productive resources. The flexibility of prices and wages to bring about full employment.

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Assumption of full employment



According to classical economists, the labour and the other resources are always fully employed. Moreover, the general over-production and general unemployment are assumed to be impossible. If there is any unemployment in the country, it is assumed to be temporary or abnormal. According to classical views of employment, the unemployment cannot be persisted for a long time, and there is always a tendency of full employment in the country.

Assumption of full employment

According to classical economists, the reasons for unemployment are: (i) Intervention by the government or private monopoly, (ii) Wrong calculation by entrepreneurs and inaccurate decisions.  Thus in a free competitive capitalist economy, the tendency of general unemployment is unlikely and there always exists full employment or tendency toward full employment.


Flexibility of Price and Wages



Apart from full employment of natural resources, the classical economists believed that it is the flexibility of prices and wages which automatically brings about full employment. If there is general overproduction resulting in depression and unemployment, prices would fall as a result of which demand would increase. When demand increases, prices rise thus productive activity will be stimulated and unemployment would tend to disappear.

Flexibility of Price and Wages



Similarly, unemployment would be cured by cutting down wages which would increase the demand for labour, and would stimulate the activity.

Say s Law


Say s law is the foundation of classical economics. Assumption of full employment as a normal condition of a free market economy is justified by classical economists by a law known as Say s Law of Markets . It was this law on the basis of which classical economists thought that the general overproduction and hence general unemployment were impossible.

Say s Law


Statement of the law: According to J. B. Say, Supply creates its own demand. In say s words, It is production which creates market for goods, for selling is at the same time buying and more of production, more of creating demand for other goods. Every producer finds a buyer. Every supply of output creates an equivalent demand for output, so that there can never be a problem of general over-production.

Say s Law


The employment of more resources will always be profitable and will take place to the point of full employment. There can be no general unemployment if workers will accept what they are worth.

Basic Assumptions of Say s Law

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The law can operate only in a free market economy. There is free flow of money incomes. As these incomes are received they are immediately spent. Savings are equal to investment. The government does not interfere in any manner with the operation of the market forces. The size of the market is limited by the volume of production.

Implications of the Law



The economic system is self-adjusting and functions automatically without being directed by any controlling authority. The government should act on the policy of laissez-faire or non-interference in economic activities. General overproduction is impossible.

Criticism of the Says Law



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Keynes in his General theory made a vigorous attack on the classical theory of employment. He bitterly criticized Says law- Supply creates its own demand. According to him: Supply may not create its own demand when a part of the income is saved. Aggregate demand is not always equal to aggregate supply. Employment in the economy as a whole can not be increased by means of a general wage cut though it may be possible in a particular industry. The classical economists looked at wages only from the employers point of view. Contd.

Criticism of the Says Law

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The economic system is not so self adjusting as it is supposed. Hence, government intervention is necessary. Wages and prices are not so flexible as was supposed. Assumption of free and perfect competition is not realistic. It is wrong to suppose that money is a mere medium of exchange and has no role in affecting output and employment. The classical theory does not explain how the level of employment is determined.

Keynesian Theory of Employment



John Maynard Keynes has not only pointed out the shortcomings of the classical theory of employment but also propounded his own theory of employment. Keynesian theory is based on short run view. According to him, volume of employment depends on the level of national income and output. But to make this happen Keynes assumed that factors of production must be constant in an economy. contd.

Keynesian Theory of Employment



That is, in the short run, Capital equipment, Labour or man power, labour efficiency and technical knowledge must be constant. Because, if these factors of production remain fixed, the national income can be increased only by employing more labour who were lying idle before. Hence, in Keynesian short run, increase in national income mean increase in employment. The larger the volume of employment the larger the national income. The smaller the volume of
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Keynesian Theory of Employment

employment, the smaller the national income and vice versa. That is why, the Keynesian theory is called theory of employment determination or theory of income determination.

Principle of effective demand



The basic idea underlying or starting point of Keynesian theory of employment is the principle of effective demand. According to Keynes, the level of employment in the short run will depend on aggregate effective demand for goods in the country. Greater the aggregate effective demand, the greater will be the volume of employment and vice versa. So, the total employment depends on the total demand and unemployment is the result of a deficiency of total demand.
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Principle of effective demand



Effective demand represents the total money spent on consumption and investment. That is, Effective demand= Consumption+ Investment = National Income (Y) = National Output (O) Since effective demand determines the volume of employment in the economy at a particular time, the deficiency of effective demand results in unemployment. Contd.

Principle of effective demand



The deficiency of effective demand is due to gap between income and consumption. As income increases, consumption also increases in smaller proportion than the increase in national income. Since, consumption is less, demand is less. The gap must be filled up by increasing investment and hence effective demand which results in increase in employment or total output or national income.

Determination of Effective Demand



Keynes used two terms to determine effective demand of an economy.

Aggregate Supply price Aggregate demand price

Aggregate supply price is the total amount of money which all the entrepreneurs in an economy, taken together, must receive from the sale of the output.
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Determination of Effective Demand



The aggregate demand price at any level of employment is the amount of money which all the entrepreneurs in an economy, taken together, do expect that they will receive if they sell the output produced by this given number of workers. The volume of employment in an economy will be determined by aggregate supply price and aggregate demand price.