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Classical economists believed that in a free market
economy there was a tendency toward the
establishment of full employment of labour and there
was sufficient demand for the output produced.

Classical theory of employment and output is based on

the following two basic notions:

1.Say's Law
2.Wage -price flexibility
u 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 ¦
 
 

 .
u Êt was the theory on the basis of which classical
economists thought that general over-
production and general unemployment are not
possible.
u According to the French economist J. B. Say,
supply creates its own demand. According to him,
it is production which creates market for
goods. More of production, more of creating
demand for other goods. There can be no problem
of over-production. According to Say, the
aggregate supply of commodities in the economy
would be exactly equal to aggregate demand. Êf
there is any deficiency in the demand, it would be
temporary and it would be ultimately equal to
aggregate supply. Therefore, the employment of
more resources will always be profitable and will
take to the point of full employment.
u ëa) Perfectly competitive market and free exchange
economy.
u ëb) Free flow of money incomes. All the savings must
be immediately invested and all the income must be
immediately spent.
u ëc) Savings are equal to investment and equality must
bring about by flexible interest Rate.
u ëd) No intervention of government in market
operations, i.e., a laissez faire economy, and there is no
government expenditure, taxation and subsidies.
u ëe) Market size is limited by the volume of production
and aggregate demand is equal to aggregate supply.
u ëf) Êt is a closed economy.
0Classical macroeconomic theory³
a view of the macro economy as
being self-adjusting
full employment
maximum output
{

government intervention.
0Classical theory was dominant from the late 18th century
through the early 20th century ëthe Great Depression).
u Classical theory
Adam Smith
3
 
 in 1776.
Who are the classical Economists? :

The term classical economist was coined by Karl

Marx to describe the economist who accepted
labour theory of value, as propounded by
David Ricardo. Later Keynes popularized this
term.
Classical Theory of Employment:

Êmpossibility of General Unemployment or over

production

´Êt is production that creates markets for goods.µ

J.B Say ´ Traite´ d· Economic Politique ë A treatise on
Political Economy )

The above mentioned phrase later became popular as

Supply creates it own demandµ.
u The cost cut via wage reduction will
decrease the price ² demand will pickup,
which increase the demand of labour
and the unemployment that was
prevailing due to temporary over
production will evaporate.
u Thus classical economists believed that
wage rigidity or other market
imperfections are the cause of
unemployment.
u With a given production function and
initial equilibrium MPP= WÎ
u
   
   

       
 

      

      

 
        
  
 
u Frictional unemployment is
consistent with full employment