This argument is based on the assumption that there is a direct and proportional relation between money wages and real wages. For fixed industrial conditions, we conclude that 'the amount of investment. The producer himself acts both as a saver and an investor. The 'marginal efficiency of capital' is defined as the annual revenue which will be yielded by an extra increment of capital as a proportion of its cost. If aggregate demand falls below aggregate supply due to aggregate saving, suppliers will cut back on their production and reduce the number of resources that they employ.
This law was stringently followed by classical economists, such as Alfred Marshall and Pigou. In addition, it can be due to wrong speculation of organizations regarding the economic condition. Money wages and real wages are directly related and proportional. The second equation fixes the level of investment Î given the rate of interest through the schedule of the marginal efficiency of capital as I s r̂. He pointed out that the capitalist system was not automatic and self-adjusting because of the non-egalitarian structure of its society. Labour Market Equilibrium: In the labour market, the demand for and supply of labour determine output and employment in the economy.
When there are unemployed resources, the classical theory predicts that the wages paid to these resources will fall. The General Theory of Employment, Interest and Money. Hansen then discusses the numerical value of a respending multiplier in a laborious case-by-case analysis pp90—96. According to Pigou, the tendency of the economic system is to automatically provide full employment in the labour market when the demand and supply of labour are equal. When money wages fall, real wages rise and vice versa. To show this let us assume that the economy produces one homogeneous and divisible good, say corn. They believed that the disequilibrium between saving and investment will lead to a decline in the interest rates.
Thus, in classical theory level of employment is determined by labour market equilibrium. Therefore, state intervention is necessary. Thus the classical theory of employment is unrealistic and is incapable of solving the present day economic problems of the capitalist world. It is by increasing the real wage rate that more workers can be employed. Total employment of a country can be determined with the help of total demand of the country. Thus whatever the price level, money wage rate changes in such a way that equilibrium real wage rate, level of employment and therefore output remain constant. It is thus clear that due to adjustment in interest rate even decline in investment does not give rise to demand deficiency problem and full-employment continues to prevail.
In Figure-3, point E represents the equilibrium level of employment because at this point, the aggregate demand curve and aggregate supply curve intersect each other. But beyond point E, as more workers are employed, diminishing marginal returns start. The classical theory assumed the prevalence of full employment. We can then analyse its effect from the diagram, in which we see that an increase in M̂ shifts r̂ to the left, pushing Î upwards and leading to an increase in total income and employment whose size depends on the gradients of all 3 demand functions. On the basis of this hypothesis, larger real reward can motivate labors to work more than prefer leisure time.
The first assumption of classical economics is that the prices of everything are flexible for example, commodities, labour and land. At a higher rate of interest i 2, the investment demand is less than the intended supply of savings. But why there is unemployed exist in real world? This is why Keynes's theory is a theory of money as much as of employment: the monetary economy of interest and liquidity interacts with the real economy of production, investment and consumption. Therefore, it can be concluded that economy would always be in equilibrium and there would be no situation of unemployment in the economy. Decides and limits the market size on the basis of production volume of an organization that makes aggregate demand equal to f. Besides this, they also advocated that the flexibility or adjustments in price of products and wages of individuals facilitate the condition of full employment. Assuming consumption demand to be constant, he lays emphasis on increasing investment to remove unemployment.
Gordon Fletcher deemed it a 'myth' that 'saving finances investment': Keynes attacked the widespread belief that investment is somehow financed by saving. We find millions of workers are prepared to work at the current wage rate, and even below it, but they do not find work. Lastly, Keynes' economic theory was criticized by , who said that Keynes ideas, while good intentioned, cannot work in the long run due to the contradictions in capitalism. In such a society, the workers sell their products, and not their labour; the products exchange against products; and thus supply creates its own demand. Further, classical economists did not consider saving as bad thing. The classical economists believed that full employment is dependent on various economic factors, such as perfect competition, objective of profit maximization, and mechanism of price.
From the practical view point also Keynes never favoured a wage cut policy. Project The Classical Theory Of Employment amd output The fundamental principle of the classical theory is that the economy is self-regulating. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantified benefits. Savings are automatically invested and equality between the two is brought about by the rate of interest 12. Nevertheless, starting with , this view of Keynesian economics came under increasing challenge and scrutiny and has now divided into two main camps. However, the difficulty in determining the level of wages, prices and interest rates drag the economy into a state of disequilibrium. It is certainly true that saving can find an outlet in hoarding whose demand is not a demand for investment.