Theory of Employment

Say’s Law of Market

Say’s law is the foundation of classical theory of employment. Say’s law, named after the French Economist J.B. Say, is a classical economic proposition that the production of aggregated output creates sufficient aggregate demand to purchase all of the output produced. In other words, Say’s law states that supply creates its own demand and over production is impossible. In Say’s words, “It is production which creates market for goods for selling each at the same time buying and more of production, more of creating demand for other goods”. Every producer finds a buyer. Every supply of output creates equivalent demand for output so that there can never be a problem of general over production. Thus, Say’s law denies the possibility of deficiency of aggregate demand.

Assumptions of Say’s Law

a)      Free Market Economy

b)      No government intervention

c)      Flexibility in internal prices

d)     Long run phenomenon

Classical theory of Employment

The classical theory of employment was developed by the combined contribution of classical economist like Adam Smith, J. B Say, J. S. Mill, David Ricardo etc.

The theory is based on the assumption of full employment of labour and other resources of the economy. Full employment refers the situation when all the people who are willing to work at the existing wage rate will get work. Thus, full employment doesn’t mean achieving zero unemployment. Zero unemployment is impossible in any real economy.

Assumption of classical theory of employment

a)      This theory assumed that closed capitalist economy.

b)      Full employment level

c)      Money acts as medium of exchange

d)     There is the existence of perfect competition in the market

e)      There is existence of wage price flexibility

1. Say’s law of market:

Same as before (not assumption)

2. Money market:

Irving Fisher states that total value of output is equal to total expenditure on final goods and services. According to Fisher the long run rate of goods and services remains constant at full employment level. Similarly, (V and V) velocity of money and velocity of bank money also remains constant. Thus, price level (p) is determined by the supply of money (M and M). There is direct relationship between money supply and price level. Hence, PT = MV + MV

3. Labour market:

Flexibility in wage rate assures labour equilibrium with full employment. Real wage rate is determined by market forces i.e. demand and supply of labour market. Demand for labour is negative function of real wage   rate whereas supply of labour is positive function of real wage rate. Real wage rate is determined and the level where demand and supply of labour are equal. This level also represents level of full employment.

4. Product market (Production function):

According to classical economist total output is decreasing function of the number of workers employed. It is due to the operation of law of diminishing returns but at the full employment level of output remains stable.

The classical theory of employment can be shown with the help of following figures:     

In figure A, DD represents demand for labour curve and SS represents supply. It intersect at point E i.e. equilibrium.

In figure B, y = fcurve indicates total production function. It slopes upward to the right and bends to the x-axis and after a point it becomes horizontal.

In figure C, two horizontal curve representing MV and M¹V¹ at corresponding level of price. It slopes downward to the x-axis.

Thus, it indicates that total output increases at a decreasing rate initially and reaches at its maximum and constant at full employment ON. At full employment level, corresponding output is OY.