classical theory of income, output and employment pdf

Lecture Note on Classical Macroeconomic Theory Econ 135 - Prof. Bohn This course will examine the linkages between interest rates, money, output, and inflation in more detail than Mishkin’s book. 2. Keynesian model has been developed as a reaction against the classical model. In addition, the government should balance its income and expenditure. The demand for labors and other factor resources are determined by the demand for the products in the market. It is to be remembered here that Y is also fixed due to the existence of full employment in the economy. Thus, we get backward bending supply curve of labour. This framework is composed of an aggregate production function, the labour market, the money market, and the goods market. Thus, it is the supply of labour which plays an important role in the determination of labour market equilibrium and thus the employment and output level. In order to maximize their profit, firms employ factors of production to the point where margi… At low level of Labour input before N1. Firms and individual workers optimize. Aggregate demand for labour is negatively related to the real wages (W/P), ND = f (W/P) (Aggregate labour demand function) …(2.4). 2.4b). Introduction to Keynesian Theory: Keynes was the first to develop a systematic theory of employment in his book. 3. Classical vs Keynesian. Assumptions 4. TOS4. The supply of money is fixed as it is supplied by the central bank. Equation (3.12) shows a proportional relationship between money stock and the price level. MC of labour is equal to the money wage divided by the marginal product of labour, MPL, i.e.. where W is the money wage, P is the absolute price level, and W/P is the real wage. National Income: Concepts, Methods and Problems in measuring National Income, Circular Flow of Income in 2, 3 and 4 sector model. Interest rate that guarantees that changes in the particular components of demands do not affect the aggregate level of commodity demand. Thus, For equilibrium in the money market, = kPY … (3.12). What is required for stable price level is the stable money supply since quantity of money determines the price level. CLASSICAL THEORY VS. KEYNESIAN III. However in this essay we will see it from another perspective: 5. Classical Theory of Income and Employment, 2. 1. Let us first consider the labour market where we deal with production function in which capital stock is fixed and labour is the variable input. Money wage is adjusted automatically by the market. Classical Model of Employment: The classical theory of employment can be summarises in equation model given below: Product Market: 1. Theories of Income, Output and Employment Determination: Classical and Keynesian; Principle of effective demand. 1. In this vedio we will understand the basic concept of output and employment determination. Increase in wages implies increase in income, therefore, a labourer is willing to work more at higher wages. Classical economists such as Adam Smith and Ricardo maintained that the growth of income and employment depends on the growth of the stock of fixed capital and inventories of wage goods. Privacy Policy3. Share Your PDF File Criticisms. Thus, it is the supply of labour which plays an important role in the determination of labour market equilibrium and thus the employment and output level. Privacy Policy3. Therefore, it is assumed that the Aggregate labour supply curve has a positive slope. Both the firms and workers have perfect knowledge about the prices. determine output, employment and real wage in the classical system. KEYNESIAN MODEL VIII. Assumptions Laissez faire Non Intervention of the Government Perfect Competition Market Mechanism Consumer and Producers freedom. Monetary sector is not concerned with relative prices and real variables. The General Theory of Employment, Interest and Money (1936). Price Level Determination: Money Market: 3. CLASSICAL THEORY OF EMPLOYMENT For this theory, French economist J. 1. B. Fig. Mill, Marshall, Pigou etc. In this section, we analyse the classical theory of aggregate price level determination. The scope of this chapter is limited to Keynesian Theory. For this, they have to determine the level of output to be produced and the number of workers to be employed. Policy Implications 10. where K denotes a constant capital stock and L denotes quantities of variable input, labour. The only way for equilibrium output to change in this classical model can be attributed to a shift in labour demand or labour supply curve. 2. Fiscal policy is an impotent instrument to influence aggregate demand. Keynes attacked not the logical consistency of the classical economic theory, but its empirical premises. Thus, we see a link between money supply and the price level: an excess money supply means increasing demand for commodities that pulls up the general price level. To build up a classical macroeconomic model, here we will consider a particular framework within which the classical system can be studied. CRITICISM OF KEYNESIAN THEORY 3. Say formulated a law which is known as the “Say's Law of Market”. The Classical Theory of Income and Employment is premised on three conjectures. The corresponding equilib­rium level of output (at the equilibrium level of employment) is YF. The quantity theory of money says that the quantity of money determines the price level. The classical theory relates only to the special case of full employment. It also depends on the extra unit of output that an additional worker can produce if added to the current workforce. 1. It is positively related to the real wages. The aggregate production function is: Y = f (K , L) … (3.2). It gives the total labour supplied at each level of real wages. The goods market equilibrium is achieved when saving is equal to investment, i.e.. A flexible interest rate in the classical system always brings equality between savings and investment. Classical Theory of Income Output and Employment | Economics | - Duration: 29:29. I. Before publishing your Articles on this site, please read the following pages: 1. The determination of output and employment in the classical theory occurs in labour, goods and money markets in the economy. Classical economists such as, J.S. Employment-Output Determination: Labour Market: 2. To do this, money market is introduced. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. The classical economists advocated that the government should follow the laissez-faire approach of economy. entire ⁄ow of output (unless taxed) goes back to the households in the form of income. Since the classical model is a supply-determined one, it says that equiproportionate increases (or de­creases) in both money wage and the price level will not change labour supply. The slope of the production function (MPN) is positive but decreases as we move along the curve. It shows at very low level of output as we employ more labour to the given capital, productivity of the last worker added does not fall. Saving implies a choice between present and future consumption. 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. The Production function is a straight line which exhibits constant returns to scale. Labour supply curve is derived from the income-leisure trade-off curve which shows the trade-off between leisure and work. 48 1.2 The Classical Theory of Employment 50 1.3 The Point Of Effective Demand as the Position of System Equilibrium 54 1.4 Summary 59 APPENDIX TO CHAPTER 1 62 2. An investment is something that is used to create value in future. TOS4. In the State of Equilibrium. The households also decide how much to consume and how much to save out of their total income. Therefore, Equilibrium level of employment → N*, as here Nd = Ns shown by point ‘e’, Equilibrium level of output →Y* (Fig. Of course, such saving then depends on the rate of interest in the classical system, and not on income as was said by J. M. Keynes. The additional Labour employed will not lead to additional production/ output i.e, MPN = 0. CLASSICAL THEORY II. Keynesian Theory of Income and Employment: Definition and Explanation: John Maynard Keynes was the main critic of the classical macro economics. Due to decrease in the profit level, firm will demand less labour. Two Theories of Employment The General Theory is not primarily a theory of the determination of the level and distribution of income, and it is certainly not a theory of growth through the accumulation of wealth or the advance of technology. The demand for money equation that will be presented here is the Marshallian cash balance version of the quantity theory of money. J. M. Keynesian theory is a general theory. Aggregate labour demand function, shown in equation (3.7), is also inversely related to the real wage rate. At ‘extremely’ higher income level, labour prefers leisure to work → IE > SE. Thus, investment, in the classical system, depends on the market rate of interest. According to Adam Smith, “it is the real factor which is more important.” Money was used only as a medium of exchange. As money supply increases from M1 to M2, the price level rises proportionately from P1to P2. Equation 3.10 states that people hold cash balance since there is a gap between money receipts and expenditures. In the classical model, it is assumed that people hold money solely to facilitate transactions. The intersec­tion between DL and SL curves at point E in the upper part of the figure determines the equilibrium level of employment (LF) at the equilibrium real wage rate (W/P)F. The equilibrium of the classical labour market is one where everyone willing to work at the real wage (W/P)F is able to find work. One important conclusion from the classical model is the classical dichotomy. Thus, demand for labour depends inversely on real wage. This means that the goods market is segmented completely from the remainder of the system. In this article we will discuss about the classical theory of income and employment. Output creates income. It is a horizontal summation of all individual labour supply curves. Disclaimer Copyright, Share Your Knowledge 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. Classical theory was propounded by RicardoClassical theory was propounded by Ricardo and Adam Smithand Adam Smith Classical theory of employment and output isClassical theory of employment and output is based on the following two basic notionsbased on the following two basic notions -Says law-Says law -Wage price flexibility-Wage price flexibility Fig. It may be noted here that the interest rate is a ‘real’ variable in the goods market. The factors which are operating on the supply side determines the level of output and employment. In this economy there cannot be over production … Content Guidelines 2. The factors which are operating on the supply side determines the level of output and employment. This is the gist of Keynesian or Macro approach. That is. It has a wider application on all such situations of unemployment, partial employment and near full employment. Like labour demand, aggregate labour supply function also depends on the real wage rate, but in a direct manner. Due to the assumption of short-run, output will be a function of Labour (N) with capital constant (K), that is, output can be increased only by increasing the variable factor (N) with fixed factor (K) constant. As capital is constant in the short-run, output will change only with change in the labour input. Say's Law of Market.

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