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. But, in the short ran, the stock of fixed capital and wage goods inventories are given and constant. According to them, even in the short run full-employment of labour force would tend to prevail as the economy would not experience any problem of deficiency of demand.
On the basis of their theory they denied the possibility of the existence of involuntary unemployment in the economy.
The short- run classical theory of income and employment can be explained through the following three stages:
1. Determination of income and employment when there is no saving
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At a lower real wage rate, more labour will be demanded or employed by the firms and vice versa. Thus, the demand curve for labour is derived from the marginal product curve of labour. In fact, the former coincides with the latter. Thus demand function for labour can be written as
Nd=f (W/P)
Consider Fig. 3.1 where MP curve depicts the diminishing marginal product of labour with a given stock of fixed capital and a given state of technology. As explained just above, marginal product (MP) curve of labour also represents the demand curve of labour (Nd).
On the other hand, the supply of labour by the households in the economy depends on their pattern of preference between income and leisure. The classical theory assumes that in the short run when population does not vary, supply curve of labour slopes upward. Now, what is the rational behind the upward-sloping supply curve of labour.
This is based on the assumption that households or individual workers maximise their utility or satisfaction in their choice of work (which yields them income) and leisure. When real wage rate rises, two effects work in opposite
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When real wage rate rises leisure becomes relatively more expensive, that is, opportunity cost or price of leisure in terms of income forgone by not working goes up. This induces the individual to work more (i.e. supply more labour hours) and thereby substitutes income for leisure. This is the substitution effect.
On the other hand, with a rise in real wage rate individuals become relatively richer than before, and this induces them to consume more of all commodities (including leisure which is regarded as a normal commodity). This is income effect of the rise in real wage rate which tends to increase leisure and reduce labour-hours supplied.
The classical economists believed that substitution effect is larger than income effect of the rise in real wage rate and as a result supply of labour increases with the rise in wage rate. Thus the supply function of labour can be written as
Ns=g (W/P)
This implies that at a higher wage rate, more labour would be supplied and vice versa. It will be seen from Fig. 3.1 that supply and demand for labour are in equilibrium at the real wage rate
Classical economics as postulated by the 19th century British economist David Ricardo states – in modern economic terms – that an economy will achieve its natural levels of employment (full employment) and reach its potential output on its own without any government intervention. While the economy may undergo periods of less than natural levels of employment or not yet reach its potential output, it will, in the long run do so. If Mr. Ricardo was still alive, his favorite album would be The Long Run by The Eagles (1979). Using modern economic terms to further describe classical economics, an economy will tend to operate at a level given by the long run aggregate supply curve. While many believe that the concepts of classical economics are for
According the book, The General Theory of the Employment, Interest and Money, Keynes argues that the level of employment is not determined by the price of labor but by the spending of money on collective demand. Also, he argues that it is wrong to assume competitive market will deliver full employment. Likewise, it is wrong to believe that full employment is natural, the self-correcting and equilibrium state of a monetary economy. In contrast, under employment and under-investment are natural states to be seen unless active measures are taken. Also, he argued that the lack of competition is not the fundamental problem and measures to reduce unemployment by cutting wages but ultimately futile. He points out that there is no self-correction property in the market system to keep capitalism going. A badly depressed economy could remain in stagnation unless some alternative of capital spending is found to revive it again. The only source of stimulation is the government. Therefore, the government...
In many nations, the relationship between labor and production has often been a tense one. On one side of the equation, businesses have insisted on greater productivity at lower costs. On the other side, labor (most often in the form of labor unions) has insisted that increased productivity can be best be achieved if the workers have a reasonable “living” wage and job security (Howard 2002).
This phase of Macroeconomic history started with the book entitled “An Inquiry into the Nature and Causes of the Wealth of Nations” written by Adam Smith in 1776. (Smith, 1904) Working of the economy was presented by the classical economists like Smith, Ricardo, Say, and Marshal etc. According to the classical economists, “Supply creates its own demand.” It means that whatever is produced in the economy is sold. So, there is no question of unemployment in a market. They also argued that savings is always equal to investment. (Shahid, 2013)In short, they proved that there is always full employment in an economy based on the following:
Income Effect: the income effect is the response of desired hours of leisure to changes in one’s income. If wages are held constant and income increases then the desired hours of work will decrease. The relevance of the income effect in regards to the study of labor economics is very important. Employers, economists and Government institutions have the ability to determine the amount of time workers’ will seek to either choose more hours of work or more hours of leisure. This can be used to estimate the average number of work and leisure hours a sample of workers will utilize in a year or during a trend.
...d supply of high paying jobs benefits the economy because it rewards those who are willing to seek the necessary precautions to reach them, which in turn creates a better stimulated and more productive work force.
Labor is another scarce resource and is allocated just the same despite many peoples emotional opinion. Prices allocate labor just the same and give corporations the incentive not to employ to much labor and have workers sit around "just in case" when they could be doing something productive. In the Soviet Union since there were no prices for labor factories would keep tons of extra workers on hand just in case they needed them, when they could have been doing something productive somewhere
In the study of macroeconomics there are several sub factors that affect the economy either favorably or adversely. One dynamic of macroeconomics is monetary policy. Monetary policy consists of deliberate changes in the money supply to influence interest rates and thus the level of spending in the economy. “The goal of a monetary policy is to achieve and maintain price level stability, full employment and economic growth.” (McConnell & Brue, 2004).
Graph A could best describe this example. This graph shows you what happens to the output when more labor is added. The output will slowly level off and then start to decline. If the managers want to maximize the output they would have to look at the max point on the graph to get the highest output with the lowest labor force.
The chain of fundamental thoughts behind this conviction takes after: as more individuals work the national yield expands, bringing about wages to build, creating purchasers to have more cash and to spend additionally, bringing about shoppers requesting more products and administrations, at long last bringing on the costs of merchandise and administrations to increment. At the end of the day, Phillips demonstrated that unemployment and inflation imparted a converse relationship: inflation climbed as unemployment fell, and inflation fell as unemployment rose. Since two noteworthy objectives for financial approach creators are to keep both inflation and unemployment low, Phillip 's disclosure was an imperative reasonable achievement, additionally represented a troublesome test: how to keep both unemployment and inflation low, when bringing down one results in raising the other?
Keynesian economists, similar to Classical economists, also believe that the economy is made up of consumer spending, government spending, and business investments. However, the Keynesian Theory says government spending can improve economic growth in the absence of consumer spending and business investment (Differences). According to the Keynesian theory, wages and prices are not flexible. A static price will give a horizontal aggregate supply curve in the short run (Classical and Keynesian Economics).
The disparities between the two views of the economy lead to very different policies that have produced contradictory results. The Keynesian theory presents the rational of structuralism as the basis of economic decisions and provides support for government involvement to maintain high levels of employment. The argument runs that people make decisions based on their environments and when investment falls due to structural change, the economy suffers from a recession. The government must act against this movement and increase the level of employment by fiscal injections and training of the labour force. In fact, the government should itself increase hiring in crown corporations. In contrast the Neoliberal theory attributes the self-interest of individuals as the determinant of the level of employment.
In chapter nine ‘Why is there an employment/inflation trade-off?’ the authors critique the natural rate theory. They agree with the fact that wage setting is influenced by expectations of inflation but disagree that inflationary expectation affects ‘wage and price setting one for one’
Ricardo’s theory is different from Smith's theory by excluding rent from the costs of production. Ricardo argues against Smith's theory because it only applies when wage is proportional to the amount of production equivalent to the amount of labor commanded and embodied. However, prices of commodities changes over time due to application of new production techniques; this leads to the increase of commodity prices over time. Ricardo points out that the value of a commodity is only equal to its cost of production in the long run.
The two most influential economists that helped to shape our economy with their thoughts and theories that are still used in modern economy are Adam Smith a classical economist and John Maynard Keynes a neoclassical economist. These two economists are the most famous economists of all times. Even though that its known that their thoughts are opposites to one and other they also share some similarities for example as suggested by (Stephen Yearwood. (2013)) “Both understood that the key to economic prosperity is to keep the money circulating.” They both According to (Greydark (2009)) Demonstrated “that the field of economics is vast, flexible, and able to be interpreted in many ways.” Each influenced the growth of economic thought and birth of modern market based societies. According to (best brielle. (2010)) “Each economist has similar ideas yet different opinions that distinguish them as economic leaders”.