Income and employment theory, a body of economic analysis concerned with the relative levels of output, employment, and prices in an economy. It was particularly the Pigovian version that Keynes attacked in General Theory. and Employment Postulates Always full employment. Classical Theory of Output. This is the level of underemployment equilibrium, according to Keynes. CHAPTER 5: OUTPUT-EMPLOYMENT THEORIES (CLASSICAL AND KEYNESIAN) 5.1 Classical Theory (A) Introduction: Employment and output analysis at macro level has become an important part of economic theory only during and after the Second World War period. Explanation of Classical Theory of Employment 5. Adam Smith wrote a classic book entitled, 'An Enquiry into the Nature and Causes of the Wealth of Nations' in 1776.Since the publication of that book, a body of classic economic theory was developed gradually. The line I 1 E 1 is the investment curve (imagine that it can be extended beyond E as in an S and I diagram) which touches the S curve at E 1.Thus OY 1 is the equilibrium level of employment and income. He views that investment multiplier is a direct function of . The classical theory had propagated a free market economy, which classical economists believed would automatically lead to full employment. The last ingredient of the Classical Theory of Unemployment is the wage schedule Pigou was of the view that under free competition there is always a tendency in the economy to provide full employment in the labour market. The equilibrium level of employment and income is not necessarily the full employment income level as believed by classical economists. Pigou constructed the classical theory (and Say’s law) to make it applicable in the labour market. Before understanding employment and output determination, major assumptions of classical theory should be looked into. Criticisms. Consequently, real wage cannot be considered as a mechanism to adjust employment anymore but labor demand does. Classical Model of Employment 6. The classical economists took full employment for granted, believed in the automatic adjustment of the economy, and, therefore, felt no need to present a proper theory of employment. and vice-versa. Assumptions of Classical Theory of Employment. Classical Theory of Employment: Definition and Explanation: Classic economics covers a century and a half of economic teaching. Assumptions Laissez faire Non Intervention of the Government Perfect Competition Market Mechanism Consumer and Producers freedom. The basic assumptions of the theory include: Supply creates its own demand. In the State of Equilibrium. Classical theory of unemployment affirms unemployment Says Law French economist Jeane Baptiste Say Supply Creates its own demand. The theory of investment multiplier establishes a precise relationship between initial increase increment of investment and the resulting increase in income and employment aggregate employment, income, given the marginal propensity to consume in short run. The classical theory of employment states that in a labor market, employment for labors is determined by the interaction between demand and supply of labor, where the workers provide a constant supply of labor, while the employer makes demand for them. Sufficient market exists for all the produced goods and services. In this economy there cannot be over production … It was J. M. Keynes who first analyzed the frequent problem of unemployment and fluctuating levels of real output or national income. Keynesian Theory of Unemployment Classical Theory of Unemployment Keynesians and New-Keynesianism declare employment and aggregate demand is what determines the real wage. Money Does not Matter. mpc. 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