Keynesian Theory of Employment: Keynes has strongly criticised the classical theory in his book ‘General Theory of Employment, Interest and Money’. But the adoption of such a policy for the economy leads to a reduction in employment. At this level whole of the full employment output is purchased. The law of diminishing returns operates in production. As explained above, the demand for labour is a decreasing function of the real wage rate. He pointed out that the capitalist system was not automatic and self-adjusting because of the non-egalitarian structure of its society. Instead he argued that it was demand that created supply. 9. Assuming V and T to be constant, a change in the supply of money (M) causes a proportional change in the price level (P). Contrariwise, with the fall in the wage from W/P0 to W/P2, the demand for labour increases more than its supply by s1d1, the workers demand higher wage. He considered it as unrealistic. In the long run, the economy will automatically tend toward full employment when the demand and supply of goods become equal. The classical theory of employment has been severely criticized by Keynes. This is shown in Panel (B), where MPN is the marginal product of labour curve which slopes downward as more labour is employed. At the equilibrium level, it is not necessary that full employment may be attained. Classical theory is based on the assumption of full employment of labour and other resources of the economy. Account Disable 12. The general situation in a capitalist economy is one of underemployment. This will remove unemployment. Maintenance of full employment level, according to Say’s law, requires that the whole of the income generated at full employment level must be spent on the purchase of the whole of the output produced at that level. So when all earned income is not spent on consumption goods and a portion of it is saved, there results in a deficiency of aggregate demand. Though the classical theory is perfectly logical in its content, but it has little practical relevance. A reduction in wages, if on the one hand produces favourable effect on employment through reduction in costs and prices, also, on the other hand, reduces income which, in turn, decreases aggregate demand and hence employment. If W is the money wage rate, P is the price of the product, and MPN is the marginal product of labour, we have W=P X MPN or W/P = MPN. The following points highlight the nine grounds on which Keynes criticized the Classical Theory of Employment. 11. 10. When the price level rises to OP1, the money wage also rises to OW1. Keynes, on the other hand has shown that the possibility of under-employment, and not full employment, is a normal phenomenon in the real capitalist world. Hence, the part of income which is not consumed (i.e. At that point of time, total demand equals total supply and the economy is in a state of full employment. In Figure-3(A), MV curve is the money supply curve which also represents demand for goods. The classical theory has failed to explain the occurrence of trade cycles. 7. The main propositions of the classical theory of employment are given below: (i) Full employment is a normal feature of a capitalist economy. Monetary factors ignore. (iv) Laissez-faire condition prevails, i.e., government does not interfere in the economic activities. It is only when the wage is reduced to W/P0 that unemployment disappears and the level of full employment is attained. The criticisms are: 1. Supply of labour (SL) is positive function of real wage (W/P). Real wage rate is determined at the level where demand for labour and supply of labour are equal. Similarly, if investment exceeds saving, income level rises, saving increases and becomes equal to investment. This will remove unemployment and once again establishes full employment level ON. General Theory: Evolutionary or Revolutionary:. According to Pigou, the tendency of the economic system is to automatically provide full employment in the labour market when the demand and supply of labour are equal. Thus there is general deficiency of aggregate demand in relation to aggregate supply which leads to overproduction and unemployment in the economy. Saving and investment are not affected by interest rate only. Supply of labour is a positive function of real wage rate; supply of labour increases with a rise in the real wage rate and decreases with a fall in the real wage rate. The Criticisms of Classical Economics: Counterarguments and Limitations One of the modern criticisms of classical economics involves a perceived lack of cohesion. It will lead to reduction in saving and ultimately the equality between saving and investment will be attained at a lower level of income. In the labour market, the demand for and supply of labour determine output and employment in the economy. Capital stock and technical knowledge are given. Say’s Law: Say’s law of markets is the core of the classical theory of employment. He developed a new economics which brought about a revolution in economic thought and policy. Total output comprises of consumer goods (C) and investment goods (I). According to classical economic theory, a market economy: is self-regulating, will automatically adjust to the natural unemployment rate, and will automatically adjust to Natural Real GDP According to Marx's criticism of classical theory: Keynes refuted Say’s Law of markets that supply always created its own demand. The main points of criticism of classical theories are as follows: a. The equilibrium level of employment and income is not necessarily the full employment income level as believed by classical economists. The forces of demand and supply in these markets will ultimately bring full employment in the economy. Thus the existence of involuntary unemployment in capitalist economies (entirely ruled out by the classicists) proves that underemployment equilibrium is a normal situation and full employment equilibrium is abnormal and accidental. On the contrary, the lower the rate of interest, the higher the demand for investment funds, and lowers the saving. It is by reducing the real wage rate that more workers can be employed. Classical Theory of Employment: Definition and Explanation: Classic economics covers a century and a half of economic teaching. (v) Under conditions of perfect completion, flexibility of wages tends to establish full employment. The Classical Vs.Keynesian Models of Income and Employment! 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