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An overview of the classical macroeconomic theory, focusing on the key postulates and principles developed by classical economists such as david ricardo, john stuart mill, robert malthus, alfred marshall, and arthur c. Pigou. The classical theory emphasizes the concept of full employment, where market forces operate to maintain a state of equilibrium in the economy. The classical view on wage rates, the relationship between aggregate demand and supply, and the implications of say's law. It also delves into the classical model of employment, which is based on the labor supply and demand functions. The document highlights the classical economists' belief that factors on the supply side of the market determine the level of employment and output, in contrast with the keynesian approach. Overall, this document offers a comprehensive understanding of the classical macroeconomic framework and its key tenets.
Typology: Summaries
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those of 18
th
and 19
th
century.
Stuart Mill, Robert malthus, Alfred Marshal and Arthur C. Pigou are regarded as classical economists
macroeconomic views of the classical economists, as envisaged by the economists of the post-Keynesian
era are treated as the classical macroeconomic postulates
assumption that the economy works on the principles of laissez-faire. The following are the features of
laissez-faire system:
There is no government control or regulation of private enterprises. If there is any government
interference, its objective is to ensure free competition.
There are no monopolies and restrictive trade practices – if there are any, they are eliminated by
law.
There is complete freedom of choice for both consumers and the producers.
Market forces of demand and supply are fully free to take their own course depending on the
demand and supply conditions.
The classical economists treated money only as a medium of exchange. According to the classical
economists, the role of money is only to facilitate the transactions. It does not play any significant role in
determining the output and employment. The levels of output and employment are determined by the
availability of the resources – labour and capital.
Overall summary of Classical Economy
the state of equilibrium at full employment.
factors of production in all industries is the same.
market system works automatically and it maintains the economy in equilibrium. Whenever there is
deviation from the equilibrium, the ‘invisible hands’ of demand and supply come into operation
and restore the equilibrium.
Say’s Law was refined by a group of classical economists and especially by David Ricardo. The
contribution of David Ricardo is known as reformulation of Say’s law.
The classical reformulation of Say’s law states that, in a capitalist economy, the total supply always
equals total demand. There cannot be any ‘general overproduction’ or ‘general underproduction’. This
means, an economy under the laissez-faire system is always in equilibrium.
The presence of overproduction or underproduction, if any, are only transitory and are caused by
external factors. This means, there might be some short-term imbalances in the demand for and supply
of some goods and services caused by the exogenous factors.
When, there is underproduction, there is excess demand in the economy, leading to price rise. The rise
in price results in the reduction of demand on one hand and the increase in supply on the other.
Again, if there is overproduction, there is excess supply in the economy, leading to fall in price. This
decrease in price leads to fal in supply on one hand, and increase in demand on the other hand.
Thus, in both the cases, the demand-supply adjustment restores the equilibrium. Thus, in the long run, a
market economy is always in equilibrium
As per the classical postulates, in a free enterprise economy, full employment is maintained. This means
that there cannot be general unemployment in a free enterprise.
The classical economists argue that full employment ensures that the actual output is equal to the
potential output and the total production is always sufficient to maintain the economy at the level of full
employment.
Unemployment, if any, is a temporary phenomenon. When unemployment exists, it pushes the wage
rate down which makes the employment of labour more profitable. This results in the increase in
demand for labour and unemployment disappears.
One important point here is, there can be voluntary and frictional unemployment present even in the
state of full employment.
Voluntary unemployment arises when
I. Potential workers are unwilling to work at the prevailing wage rate
II. Workers go on a strike
Frictional unemployment arises when workers remain temporarily out of job due to labour
market imperfections, immobility of labour, seasonal nature of occupation as in agricultural
activities, technological changes, natural calamities, wars, etc.
1. Aggregate Production Function
the employment of capital and labour. It is denoted as
Where Y is the real output, K is the capital and L is the number of labour.
The stock of capital, K is fixed
Technology of production used by the firms is given
Population is constant
The labour is homogenous in nature
Diminishing marginal productivity of labour, which means that with an increase in the employment
of labour, the marginal productivity of labour decreases.
national output in the short run is the function of the employment of labour drawn from a constant
population.
national output is maximum.
production function
the existence of diminishing marginal
productivity of labour.
ON and the total amount of output is MN.
produces.
necessary condition for profit maximization of a firm is MR = MC.
production of one additional unit of output can be expressed as marginal wage (MW).
the marginal revenue productivity of labour. Thus, the profit maximizing condition can be expressed as
demand curve.
demand decreases. If the wage rate is Rs 80, the
demand for labour is 4 workers as it this level,. As
the wage rate declines to Rs 40, the demand for
labour increases to 5 workers.
0
L
MW
80
40
4 5
the market determine the level of employment.
labour supply curve. However, labour demand is determined from the production function based on a
given technology, which is determined exogenously. The labour demand thus, can be termed as a given
law or fact.
important role in the determination of labour market equilibrium and employment. In turn,
employment determines the level of output.
on the supply side of the labour market.