MODULE ONE: TOPIC 2

SCHOOLS OF THOUGHT Classical Economists Adam Smith Keynesian Economists John Meynard Keynes

MAJOR DIFFERENCES IN THE SCHOOLS OF THOUGHT regarding INCOME and EMPLOYMENT Classicals There is a built-in tendency for the economy to be at full employment. Keynesians The level of income and employment is determined by the level of economic activity in the economy, and is given by the interaction of aggregate demand and supply.

UNEMPLOYMENT AS WE KNOW IT Unemployment is defined as those who are willing to work and are actively looking for a job but who are without one. Unemployment as we know it can be : (1) Seasonal (2) Technical (3) Structural (4) Cyclical (5) Frictional

ALL OF THESE TYPES OF UNEMPLOYMENT ARE INVOLUNTARY

CLASSICAL THEORY OF UNEMPLOYMENT full employment Classical economists believed that there is a built in tendency for the economy to be at full employment. This is based on the following: (1) The working of the free market price system which removes any unemployment which may occur. (2) A deficient demand cannot occur because “supply creates its own demand”. (SAY’S LAW)

SAY’S LAW (Jean-Baptiste Say) “Supply creates its own demand” This law implies that any increase in output will generate an equivalent increase in income and spending. Since human wants are unlimited, idle resources will be utilized to produce additional goods and services for the satisfaction of wants. Additional production will generate an equivalent amount of income which will automatically be spent on the new products. This process will continue to take place until the full employment level is achieved.

SAY’S LAW (continued) Even if unemployment were to develop, it would be temporary because the operations flexible prices in all markets will eliminate any disequilibrium and bring the economy to full employment. These flexible prices are : Wage Rates Interest Rates Commodity Prices

Who do Classicals Blame? Market Imperfections Sticky Wage Rates Minimum wage law Monopoly Price fixing Credit Restrictions by banks and finance companies

Essentially Essentially : Classical economists do not recognise the normal causes of unemployment. In their view the only cause of unemployment is the result of real wages being too high, resulting in employers not being able to employ as many workers that would like to work at a wage rate above the equilibrium point.

These principles are based on: The fact that the demand for labour is a function of the MPP of labour. This decreases as more workers enter the labour market. The supply of labour increases as wages rise.

DIAGRAMATICALLY Supply of Labour Demand for Labour O L2 L1 L3 W/P2 W/P1 Unemployed Quantity of Labour Real WageReal Wage