Theory of emplyment

CLASSICAL THEORY OF EMPLOYMENT
For this theory, French economist J. B.
Say formulated a law which is known as
the “Say's Law of Market”.
Classical economists such as, J.S. Mill,
Marshall, Pigou etc. have supported this
law of J.B. Say.
The theory of employment developed by
classical economists is called classical
theory of employment.

Classical economists assumed full
employment in the free market economic
system.
According to their views, under perfect
competition, unemployment will be
temporary and after sometime, it will
disappear.
Even at times, if full employment is not
realized, then this will gradually move
towards full employment.

SAY’S LAW OF MARKET
Say’s law of market is the foundation of
classical economics. This law has been
named for the French economist J.B. Say, a
famous economist of 19th century.
The theory of full employment of classical
economists is based on J.B. Say’s law of
market.
According to him, “Supply creates its own
demand”. It means that production of goods
will create demand for them also.

Assumptions:
1. There is existence of free market economy.
2. There is absence of government intervention in
the automatic working of the economy.
3. The size of market is flexible enough for
expansion.
4. Money is only a medium exchange.
5. There is closed economy which has no
international trade relations.
.

5. Perfect competition exists in both factor and
product market.
6. Individuals are rational human beings and are
motivated by self-interest.
7. There is no leakage in the circular flow of
income between different economic units.
8. Wages and prices are flexible.
9. Saving equals to investment

CRITICISMS
3. Supply does not create its own demand.
2. Money is also demanded for other
purposes.
3. Economy is not self-adjusting.

DETERMINATION OF EMPLOYMENT AND
OUTPUT IN THE CLASSICAL MODEL
Assumptions
 The classical theory of employment is based
on the following assumptions:
 Individuals are rational human beings and are
motivated by self-interest.
 Perfect competition exists in both product
market and factor market.
 Individuals do not suffer from money illusion.
 Laissez-faire condition prevails, i.e.
government does not interfere in the economic
activities.

 There is closed economy which has no
international trade relations.
 Technique of production and business
organizations do not change.
 Money is only a medium of exchange.
 Wage and prices are flexible both upward and
downward.
 The labour force is homogeneous.
 There is full employment in the economy.

Y
E
JI
K L
O X
DL
SL
N2 N N1
Fig (a)
Unemployment
Real
Wage
Rate
1
2
Y Fig (b)
Y = f (N)
EmploymentN
O
Outp
ut
Y

Saving and Investment
Rate
of
Intere
st
S
I
ER
R2
R1
Y
M
O
Excess
Saving
Excess
Investment
I
S

CRITICISMS OF CLASSICAL THEORY OF EMPLOYMENT
1. Under-employment Equilibrium:
2. Supply does not create its own Demand.
3. No automatic Adjustment:
4. Government Intervention:
5. Role of Money:
6. Saving-Investment Equality:
7. Long-run Analysis:
8. Assumption of Perfect Competition:
9. Not a General Theory:
10. Not a Practical Theory

KEYNESIAN THEORY OF EMPLOYMENT
J.M. Keynes
 "The General Theory of employment, Interest
and Money" published in 1936.
 The classical and the neoclassical economists
almost neglected the problem of unemployment.
 They regarded unemployment as a temporary
phenomenon and assumed that there is always a
tendency towards full employment.
It was Keynes who led vigorous and
systematic attack on the classical theory of
employment and replaced it with more general
and more realistic theory.

Assumptions:
1. Keynes confines his analysis to the short-
period.
2. He assumes that there is perfect
competition in the market.
3. He assumes closed economy ignoring
effect of foreign trade.
4. His analysis is a macroeconomic analysis,
i.e., it deals only with aggregate facts.
5. He assumes operation of the law of
diminishing returns or increasing cost.
6. He assumes that labour has money
illusion.

Principle of Effective Demand
The origin of Keynesian theory of employment
is based on the principle of effective demand.
Effective demand is that point where aggregate
demand curve intersects the aggregate supply
curve
Determinants of Effective Demand
. 1. Aggregate Demand Functions (ADF)
2. Aggregate supply function (ASF)

1. Aggregate Demand Functions (ADF)
Aggregate demand function is the relationship
between the level of employment and the expected
income from the sale of output resulting from the
varying level of employment. The expected income
from the sale of output resulting from such
different level of employment is called aggregate
demand price (ADP) for the output.

AD
Employment
XO
Cost
and
Reve
nue
Y

2.Aggregate supply function (ASF)
Aggregate supply function is defined as the
amounts of money which the entrepreneur must
get from the sale of output at varying levels of
employment. In other words, it represents
different levels of income which the entrepreneur
will supply at different levels of employment.

AS
Employment
XO
Cost and Revenue
Y

Determination of Equilibrium Level of
Employment by the Principle of effective
Demand
According to Keynesian theory, the equilibrium
level of employment is determined at the point
of intersection between aggregate demand
function and aggregate supply function. This
has been shown in the following diagram:

O N1 NN2
R2
R3
AD
X
Employment
Cost and
revenue
Y
E
AS
R
R1

Criticism
1.Not a complete theory:
2.Based on the unrealistic Assumption of perfect
Competition:
3.No direct relationship between unemployment
level and effective demand:
4.Short-run analysis:
5.Ignores microeconomic problems:
6.Static in Nature:
7.Assumption of closed economy:
8.A depression economics:
9.Capitalistic theory:
10.Not applicable in the developing countries

Theory of emplyment

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