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Classical Theory of Employment

The classical Theory of Employment can be summarized as below:

(1)    According to the classical economists, full employment is a normal situation and unemployment is a rare exception.

(2)    At the full employment equilibrium there is no possibility of involuntary unemployment. However, there could be voluntary unemployment, frictional and structural unemployment.

(3)    Equilibrium in the labour market is determined by the production function and the demand and supply of labour. The demand for labour depends upon the marginal revenue product of labour. The supply of labour depends upon the real wage rate. The equilibrium level of output, employment and income is determined in the labour market by the equality between the demand for labour and supply of labour.

(4)    Equilibrium in the money market is determined by the demand for money and the supply of money. While the demand for money is the multiple of ouput and the price level, the supply of money is the multiple of quantity of money and its velocity of circulation. Since quantity of money and level of output remain constant in the short-run, a direct proportional relationship is established between quantity of money and the price level.

(5)    In the commodity market, equilibrium is established by the equality between saving and investment. Bothe saving and investment are the functions of the rate of interest. Whereas saving is directly related to the rate of interest, investment is inversely related to the rate of interest. The flexibility of the rate of interest brings about equality between saving and investment at the full employment level.

Symbolically, full employment equilibrium in the classical model can be expressed as follows:
(i)    Equilibrium in the labour market W/b = MPPN.
(ii)    Equilibrium in the money market MV = PQ.
(iii)    Equilibrium in the commodity market I = S.

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