Answer to Question #280518 in Macroeconomics for Veenika

Question #280518

Critically explain the classical theory of income and employment Is it relevant in 21st century.


1
Expert's answer
2021-12-17T12:01:09-0500

Classical Theory of Income and Employment and its relevance in the 21st century

The theory was proposed by John Maynard Keynes in 1936. It stated the existence of full employment in the economy and that it is the norm in a free market system. It also stated that an economic system will automatically provide full employment in the labor market when the demand and supply of labor are equal.

According to the theory, unemployment rises due to interference in the working of the free market system in the form of trade union legislation or minimum wage legislation and the rigidity in the wage structure and that full employment exists for anybody willing to work at the current wage rate.

The population not willing to work at the current wage rate is thus voluntarily unemployed and thus there is no possibility of involuntary unemployment where the population is willing to work at the current wage rate but cannot find work.

The assumptions of this theory are:

1.     There exists full employment without inflation

2.     The economy is closed without foreign trade

3.     The market is free without government interference

4.     Labor and product markets are in perfect competition

5.     Labor market is homogeneous

6.     Wages and prices of goods are perfectly flexible.

7.     Money wages and real wages are directly related and proportional

The classical theory has become less relevant with the rise in globalization and has been replaced by the Keynesian theory.


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