(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 employerís 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 workersí
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
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. Letís 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. Letís
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 consumersí 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 consumerís 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.
2 Keynes' Employment Theory
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