Question

What is the role of the labor market in the Classical Model? What does it tell us? What does it not tell us?

Answer 1

The classical theory of labor market is also known as the classical theory of employment which believes in the existence of full employment in the economy.

The full employment in the labor market means where every able bodied person who is willing to work at the prevailing wage rates find employment or a situation where exists no involuntary unemployment.

The classical theory believes in equilibrium level where demand for labor is equal to the supply of labor at the prevalent wage rate.

In the classical model, equilibrium level of output is determined by the employment of labor. The level of output and, hence, the level of employment is established in the labor market by the demand for and supply of labor.

The theory is mainly based on two assumptions that is Overproduction and Flexibility of prices and wages.

It assumes overproduction to be the general conditions of the economy, thus propagating the believes of non-existence of unemployment. As the theory assumes overproduction to be the general condition of the economy, the prices of the products decreases due to overproduction thus raising the demand and consumption expenditure resulting in increased employment opportunities. Similarly it believes in cutting down the wage of labor to enhance the wage for labor and reduce unemployment.

Equilibrium real wage rate and the equilibrium level of employment are determined at that point where the negative sloping labor demand curve cuts the positive sloping labor supply curve. Once we know the equilibrium level of employment from the aggregate production function we can derive the equilibrium level of output.

It may be aded here that the volume of output and employment in the classical system are determined by only supply side of the market for output. Since, the classical model is a supply-determined one, it says that equiproportionate increases (or decreases) in both money wage and the price level will not change labor supply.