theory of employment 2

8/6/2019 Theory of Employment 2

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Theory of Employment


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Classical theory of employment

The classical economists did not formulate anyspecific theory of employment. They only laiddown certain postulates:

1. The assumption of full employment of labour andother productive resources.

2. The flexibility of prices and wages to bring aboutfull employment.


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Assumption of full employment

According to classical economists, the labour andthe other resources are always fully employed.Moreover, the general over-production and general

unemployment are assumed to be impossible. Ifthere is any unemployment in the country, it isassumed 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 employmentin the country.


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Assumption of full employment

According to classical economists, the reasons forunemployment are:

(i) Intervention by the government or private

monopoly,(ii) Wrong calculation by entrepreneurs and

inaccurate decisions.

Thus in a free competitive capitalist economy, thetendency of general unemployment is unlikely andthere always exists full employment or tendencytoward full employment.


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Flexibility of Price and Wages

Apart from full employment of natural resources, theclassical economists believed that it is the flexibilityof prices and wages which automatically brings

about full employment. If there is general overproduction resulting in

depression and unemployment, prices would fall asa result of which demand would increase. When

demand increases, prices rise thus productiveactivity will be stimulated and unemployment wouldtend to disappear.


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Flexibility of Price and Wages

Similarly, unemployment would be cured by cuttingdown wages which would increase the demand forlabour, and would stimulate the activity.


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Says Law

Says law is the foundation of classicaleconomics. Assumption of full employment as anormal condition of a free market economy is

justified by classical economists by a law knownas Says Law of Markets.

It was this law on the basis of which classicaleconomists thought that the generaloverproduction and hence generalunemployment were impossible.


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Says Law

Statement of the law:

According to J. B. Say, Supply creates its owndemand. In says words, It is production

which creates market for goods, for selling is atthe same time buying and more of production,more of creating demand for other goods. Everyproducer finds a buyer.

Every supply of output creates an equivalentdemand for output, so that there can never be aproblem of general over-production.


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Basic Assumptions of Says Law

1. The law can operate only in a free marketeconomy.

2. There is free flow of money incomes. As these

incomes are received they are immediatelyspent.

3. Savings are equal to investment.

4. The government does not interfere in anymanner with the operation of the marketforces.

5. The size of the market is limited by the volume

of production.


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Implications of the Law

The economic system is self-adjusting andfunctions automatically without being directedby any controlling authority.

The government should act on the policy oflaissez-faire or non-interference in economicactivities.

General overproduction is impossible.


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Criticism of the Says Law

Keynes in his General theory made a vigorous attackon the classical theory of employment. He bitterlycriticized Says law- Supply creates its own demand.

According to him:

I. Supply may not create its own demand when a part ofthe income is saved. Aggregate demand is notalways equal to aggregate supply.

II. Employment in the economy as a whole can not be

increased by means of a general wage cut though itmay be possible in a particular industry.

III. The classical economists looked at wages only fromthe employers point of view. Contd.


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Criticism of the Says Law

IV. 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.

V. Assumption of free and perfect competition is not

realistic.

VI. It is wrong to suppose that money is a mere medium

of exchange and has no role in affecting output and

employment.

VII. The classical theory does not explain how the level of

employment is determined.


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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.


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That is, in the short run, Capital equipment,Labour or man power, labour efficiency andtechnical knowledge must be constant.

Because, if these factors of production remainfixed, the national income can be increased onlyby employing more labour who were lying idlebefore. Hence, in Keynesian short run, increasein national income mean increase inemployment.

The larger the volume of employment the largerthe national income. The smaller the volume of

contd.


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employment, the smaller the national income

and vice versa.

That is why, the Keynesian theory is called

theory of employment determination ortheory of income determination.


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Principle of effective demand

The basic idea underlying or starting point ofKeynesian theory of employment is the principleof effective demand. According to Keynes, thelevel of employment in the short run will

depend on aggregate effective demand forgoods in the country. Greater the aggregateeffective demand, the greater will be the volumeof employment and vice versa.

So, the total employment depends on the totaldemand and unemployment is the result of adeficiency of total demand.

Contd.


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Effective demand represents the total moneyspent on consumption and investment.

That is,

Effective demand= Consumption+ Investment= National Income (Y)

= National Output (O)

Since effective demand determines the volumeof employment in the economy at a particulartime, the deficiency of effective demand resultsin unemployment. Contd.


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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 nationalincome. 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 outputor national income.


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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 thesale of the output.

Contd.


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theory of employment 2

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