Essay on the Classical Theory of Employment

J.M. Keynes referred to these assumptions as the postulates of the classical economists. According to him these postulates were based on deductive logic and had little or no empirical evidence in support. The main plank of the classical thought was the Say’s Law of Markets.

Let us introduce these postulates briefly below to summarize the main contention of the classical school of thought:

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1. Existence of full employment:

Existence of full employment of productive resources is a normal situation. Deviations from it, if any, disappear in the long- run through a self-adjusting process. If unemployment arises, the unemployed factors slash their prices to regain employment.

This generates fresh demand for them with the result that full employment is restored again through downward wage-flexibility. In classical view, full employment means employment of all the resources except those in frictional and in voluntary unemployment.

2. Existence of equilibrium in the economy:

Just as full employment is a normal situation, so is the state of equilibrium in the long run. This follows again from the automatic adjustment process. A state of disequilibrium may arise from overproduction or underproduction.

Overproduction leads to excess supply, which in turn leads to a price cut or to an emergence of unsold stocks. In either case, losses follow, to avoid which, curtailment of production is the ultimate requirement and restoration of equilibrium, the ultimate consequence.

In the event of underproduction, product price and profitability both go up. This necessitates higher employment of factors, which in turn leads to an increase in production. The state of equilibrium is restored again in the long run.

Both the postulates of the classical theory are based on the assumptions of perfect competition and laissez-faire {free trade) system. Perfect competition ensures free play of price mechanism and laissez-faire system ensures free flow of goods and services across the territorial boundaries.

3. Neutrality of money:

For classical economists, money has no other function except to serve as a medium of exchange. It facilitates transactions and that is almost all. Determination of output and employment are almost independent of money.