Classical Economics and its
Assumptions
Prof. Mahendra Kumar Ghadoliya
In Macroeconomics Income and Employment are
interchangeable terms, since in the short-run National income depends on the
total volume of employment or economic activity in the country. As income and
employment are synonymous the employment theory is also called income theory.
It should be clear to readers that the classical
economists did not formulate any specific theory of employment as such. They
only laid down certain postulates which subsequently developed as a theory.
Classical Economists
The term classical economist was first used by Karl
Marx to describe economic thought of David Ricardo and his predecessors
including Adam Smith. Classical economists viewed labour as a significant
measure of value than money. Later, classical economists gave more importance
to marginal productivity for determination of value. Keynes regarded Ricardo
and his followers like John Stuart Mill, Alfred Marshall and A.C. Pigou as
classical economists. According to Keynes classical economists refer to
traditional or orthodox principles of economics which had come to be accepted by
and large by the well known english economists since the time of David Ricardo.
They were so widely accepted and well established for over more than a century
that they were labelled ‘Classical’.
Basic Features or Assumptions of Classical
Economics:
There are two broad features of classical economics;
(a) The assumption of full employment of labour and other productive resources
in the economy, and (b) the flexibility of prices and wages to bring about full
employment.
1.
Assumption of
full Employment: The classical
economists had a great faith in the equilibrating forces of the economy at full
employment. According to them, the situation of general over production and
hence general unemployment cannot be a long run phenomenon. The disturbance or
deviation from this point of full employment if any was temporary and that the
normal situation is only of full employment. If at any time unemployment
persists for a long time, according to classical economists, it is because of
interference by the government or private monopoly with the free play of market
forces, or wrong calculations of businessmen or artificial resistance in the
economic system. Thus, the disequilibrium or disturbance is a temporary
phenomenon and that there is a full employment or a tendency towards
equilibrium at full employment in an economy.
2.
Labour is homogeneous: The quality of
labour does not differ it is homogeneous.
3.
Policy of ‘laissez
faire’: The classical economists had a
great faith in the free functioning of market forces known as ‘laissez
faire’. The classical economists believed that only this policy guarantees
stable equilibrium at full employment. The perfect competition and profit
motive are the forces that are automatic and capable enough to cure any ills in
the economic system.
4.
Perfect
Competition in the labour market
and commodity market.
5.
Price mechanism: The free functioning of price mechanism through
the forces of demand and supply ensures full employment equilibrium. The price mechanism
does the work of allocation of resources and determination of their reward.
They do not answer the question regarding the level of employment but only say
there will be full employment.
6.
Perfect
knowledge and market information to all
the participants.
7.
Price wage
flexibility: The most important
feature of the classical theory was the assumption of price wage flexibility which
automatically brings about full employment. In times of depression and
unemployment resulting from general over production in the market the prices
would go down as a result of which demand would go up. This rise in demand
would automatically cure the depression. Similarly, unemployment would be cured
by cutting down wages. As a result of wage cut the demand for labour would go
up stimulating economic activities in the economy.
8.
Money wages and
real wages are directly related and proportional.
9.
The theory applies only in the long run.
10. Savings and Investment are always equal. The rate of interest is the linking variable. If
at any point of time there is mismatch between the two the changes in the rate
of interest guarantees the equilibrium between the two.
11. Capital stock and technical knowledge remain fixed
in the short run.
12. They had full faith in the Say’s law of market. Supply creates its own demand. The economy may
not face the conditions of over production.
Full employment so assumed by classical economists
is consistent with a certain amount of voluntary unemployment and frictional
unemployment. In the Classical theory of full employment there is no place for
involuntary unemployment. Classical economists were not ready to believe that
work would not be available to the workers if they were willing to work. But,
there is unemployment in the society and it is not difficult to find people
without job. According to classical economists this was due to interference
with the free working of economic forces. Thus, the cure of unemployment is to
remove all interference whether by collective action of trade unions or by the
government. The free and unrestricted working of economy would guarantee full
employment equilibrium in the economy.
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