7 Main Grounds on Which the Classical Theory of Full Employment Is Criticized By Keynes

This is because a capitalist economy does not work according to Say’s Law of Market. Aggregate demand (AD) and aggregate supply (AS) can be equal at less than full employment.

There are large number of people is an economy who are ready to work at the current wage rate, but they do not get job.

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Thus, the existence of involuntary unemployment proves that under employment in normal situation and full employment equilibrium is by chance. Great depression of 1930’s proved the assumption of full employment in realistic.

2. Weaknesses of say’s law of market:

Classical theory is based upon Say’s Law of Market. Keynes’ success invalidates Say’s Law through the concept of Marginal propensity to consume (MPC).

MC is always less than one. Hence saving gap arises in the system. Rate of interest alone cannot bring equality between saving and investment.

It savings are not automatically invested then aggregate demand (AD) falls short of aggregate supply (AS). This leads to general over production and general unemployment.

3. General Wage-cut cannot Increase employment:

Keynes criticized Pigou’s contention that cut in money wages will lead to full employment with the fall in money wages, the income of the workers falls.

The fall in workers income reduces the aggregate demand and fall in AD would result in more unemployment.

In addition to it, are democratic country trade unions will oppose the general wage-cut. General wage-cut will create industrial interest in the economy and thereby AD will fall due to fall in investment.

Therefore, general wage-cut is not a practical proposition. Moreover, the real wages may not fall with fall in money wages.

4. Economic system is not self-adjusting:

It is argued that a capitalist system is not automatic and self-adjusting because of the egalitarian structure of its society.

Had the capitalist system been automatic and self-adjusting then great depression of 1930’s would not have occurred.

Due to market imperfection capitalist system is not automatic. Therefore government intervention is necessary to bring about equilibrium between demand and supply. In fact, state intervention reforms the capitalistic system and does not destroy it.

5. Saving and investment are not interest elastic:

Classical theory holds good only if saving and investment are equal at the level of full employment.

To classists the equality between saving and investment is brought by the flexibility of interest rate.

Keynes criticized this contention. Keynes pointed out that saving depends upon the level of income, and investment is a function of rate of interest and marginal efficiency of capital.

The mere change in rate of interest does not bring equality between saving and investment. The equality between S and I is brought about by change in income and not by change in interest alone.

6. Unrealistic assumption:

Classical theory assumes (i) perfect competition (ii) perfect mobility of factors of production and (iii) money is only a medium of exchange.

Imperfect competition rather than perfect competition prevails in the market. The factors of production are not perfectly mobile.

Money is not merely a medium of exchange. In other words money is not a passive and neutral factor.

In fact money supply affects economic activities Money is a powerful variable which affect rate of interest, investment, production etc. Money serves as a store of value.

7. Ignored the Short-run Problems:

The classical economists are of the view that self adjusting system tends to bring full employment in the long-run.

There can be unemployment in the short-run. Thus, it concentrates on long- run problem. But to Keynes solution of short-run problem of unemployment is more important. He asserted, “In the long-run we are all dead.”

In the end it can be said that the Classical theory of employment committed the mistake of applying the conclusions of partial equilibriums to the entire economy. Therefore, it is not a general theory of income and employment.