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. It was J. M. Keynes who first analyzed the frequent problem of unemployment and fluctuating levels of real output or national income. Before Keynes’ General Theory (1936) there was hardly any important and serious discussion of the problem of unemployment. However, some underlying issues were discussed by the classical economists. The classical school between 1770 to 1870 mainly includes such leading economists as Adam Smith, David Ricardo, J.B. Say, John Stuart Mill and Karl Marx. The later neo-classical economists like Alfred Marshall (between 1870 to 1930) had hardly anything to add to the classical theory. Professor A. C. Pigou, the contemporary of Keynes strongly justified classical approach and was critical of Keynes’ new theory. Keynes therefore has regarded all of his predecessors as classical economists in this context. The classical theory is based on the automatic self equilibrating tendency of the economic forces.

(B) Say’s Law: The classical theory of employment rules out the possibility of any general and prolonged unemployment. The classical employment analysis is based on the Market Law of the French economist J. B. Say. The law is simply a description of market exchange activity: "Supply creates its own demand." This apparently simple statement has serious implications. Usually, for an individual good of a smaller seller this statement appears to be a truism. Such a businessman would make suitable adjustments in the price he charges and would clear the market for the supply that he intends to make. If on a particular day he observes that his supply is exceeding demand, then assuming that the good he supplies is extremely perishable (the supply of which cannot be withdrawn or postponed), he will lower the price somewhat and thus create sufficient demand for it. So far so good. However, it is important to remember the classical economists and Say’s Law were concerned not with a single good and a single supplier of it. The law is a generalization at the macro-level where all varieties of goods and services are supplied. This law in particular meets with serious limitations when an attempt is made to make it applicable to the labor market and to the conditions of employment level.