(C) The Classical Approach: If the principle of supply creating its own demand is made applicable to the labor market, one would wonder what its effect would be. The number of workers may be in excess of the available job opportunities and the employer’s demand for their services. Therefore at the existing or going market rate of wages all available working force cannot be absorbed. Some workers will be rendered superfluous and will remain unemployed. The classical answer to the problem is that like all other goods and their prices workers’ wage rate should be cut or lowered so that the employers will be induced to employ more number of workers. The condition of full employment can then be restored if workers are agreed upon the wage cut solution. Thus flexible rate of wages is a classical approach to solve the problem of unemployment.

It is possible that some workers may resist a cut in the wage rate and may remain unemployed. But according to the classical viewpoint such unemployment is only voluntary in nature. Moreover individual employers face excess supply of labor conditions. Therefore such unemployment is only temporary and partial in nature. With the acceptance of the law: "Supply creates its own demand", there cannot be any prolonged, involuntary and general unemployment situation in the economy. The classical theory therefore rules out any general or widespread kind of unemployment. This sort of classical assertion is a result of the typical approach of the classicists to the capitalist free enterprise system. They believed in the self-equilibrating nature of such an economy. Even if there are any disturbances in the initial equilibrium conditions these are temporary and minor. Moreover, these can be cured automatically and spontaneously. There is an in-built flexibility in the supply and demand forces which leads the economy towards restoration of the equilibrium condition. Therefore general equilibrium in such a private and free economy is a rule and any disturbance or disequilibrium is only a momentary exception.

(D) Classical Solution Illustrated: The classical solution to overcome temporary and marginal gaps between demand and supply: forces is in the form of flexible wage rates and flexible prices. This can be illustrated. At the macro level of economic operations the prices include a variety of prices of goods and services, wage rates, interest rates, rent of land etc. Let’s therefore illustrate it with the movements in the rate of interest. This should however be treated as of symbolic importance. What is true about rate of interest is equally true under the classical system about wage rates of all other prices. Let’s assume that for some reason the consumers decide not to spend the whole of their income. This would cause a fall in the demand. With such a shrinking in the consumers’ aggregate demand all the goods and services offered for sale in the market cannot be sold. In the market there would exist the condition of excess supply. The producers would be worried that this may eventually cause a fall in the price level and thereby a fall in their profit margin. Therefore the firms would be inclined to restrict their production and reduce their particular demand for factor services. Hence an initial fall in the consumer’s demand ultimately results into the unemployment condition. But in view of self-equilibrating nature of the economic activities, at this point one can bring in the flexible price solution of the classical argument. We illustrate this with the help of a figure which shows the aggregate savings and aggregate investment curves. In this case with a fall in the aggregate demand for consumption goods, a compensating increase in investment expenditure takes place, with appropriate changes in the rate of interest.

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Index

5. 1 Classical Theory
5. 2 Keynes' Employment Theory

Chapter 6