Classical Theory of Employment
The classical economists believed that there was always full employment in the economy. In the case of unemployment, a general cut in money wages would take the economy to the full employment level. Full employment refers to a situation when all the persons who are willing to work at the existing wage rate will get work. This argument is based on the assumption that there is a direct and proportional relationship between money wages and real wages.
Assumptions
The classical theory of employment is on the following assumptions:
1) Full employment is a normal feature of a free capitalist closed economy in the long-run.
2) Individuals are rational human beings and are motivated by self-interest.
3) Money acts as a medium of exchange. Individuals do not suffer from money illusion.
4) Techniques of production and organizational structure of business do not change.
5) There is the existence of perfect competition in all markets (i.e. product market, labor market, and money market)
6) People spend their entire income either on consumption or on investment.
7) Wages, interest and price level are flexible.
8) There is an operation of the law of diminishes returns in the productivity of labor.
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