UNIT 3
Theories of Output and Employment
Introduction to the Classical Theory:
The classical theory assumes over the long period the existence of full employment without inflation.
Given wage-price flexibility, there are automatic competitive forces within the economic system that tend to keep up full employment, and make the economy produce output at that level within the end of the day .
Thus, full employment is considered a standard situation and any deviation from this level are a few things abnormal since competition automatically pushes the economy toward full employment.
The classical theory of income, output and employment relies on the subsequent assumptions:
1. There's a standard situation of full employment without inflation.
2. There's a laissez faire capitalist economy without foreign trade.
3. There's perfect competition in labour, money and goods markets.
4. Labour is homogeneous.
5. Total output of the economy is spited between consumption and investment expenditures.
6. The amount of money is given. Money is just a medium of exchange.
7. Wages and prices are flexible.
8. Money wages and real wages are directly related and this relationship is proportional.
9. Capital stock and technological knowledge are given within the short run.
Now we study the three pillars of classical theory.
Say’s Law of Markets:
Say’s Law of Markets is that the core of the classical theory of employment. Jean Baptiste Say, an early 19th century French Economist gave the proposition that “Supply creates its own demand.” this is often referred to as Say’s Law. In Say’s own words, “It is production which creates markets for goods. A product is not any sooner created than it, from that instant, affords a marketplace for other products to the full extent of its own value. Nothing is more favourable to the demand of 1 product, than the supply of another.”
In its original form, the law was applicable to a barter economy where goods are ultimately sold for goods. Every good delivered to the market creates a demand for a few other goods. Say argued that since work is unpleasant, nobody will work to create a product unless he wants to exchange it for a few other product which he desires.
Therefore, the very act of supplying goods by a huge number of small producers implies a demand for them from producers of other goods. In each a situation there can't be general over-production because supply of goods won't exceed demand as an entire.
Classical conceded that specific good could also be overproduced because the producer incorrectly estimates the number of the product which others want. But this is"> this is often a temporary phenomenon for the surplus production of particular product can be corrected in time by reducing its production.
Even after 100 years, James Mill supported Say’s Law in these words, “Consumption is coextensive with production and production is that the cause, and therefore the sole explanation for demand. It never furnishes supply without furnishing demand, both at the same time and both to an equal extent…. Regardless of the amount of annual produce; it can never exceed the amount of annual demand.”
Thus supply creates its own demand and there can't be general overproduction and hence general unemployment.
The classical logic was that existence of money doesn't alter the working of the fundamental law. “Say’s law, during a very broad way, is,” as Professor Hansen has said, “a description of a free-exchange economy. So conceived, it illuminates the reality that the major source of demand is that the flow of factor income generated from the method of production itself. When producers obtain the varied inputs (land, labour and capital) to be utilized in the assembly process, they generate the required income accruing to the factor owners in the type of rent, wages and interest.
This, in turn, causes adequate demand for the goods produced. During this way, supply creates its own demand. This reasoning relies on the assumption that all income earned by the factor-owners is automatically spent in buying commodities which they assist to produce.
Classical further maintained that what's not consumed is saved which all saving out of income is automatically invested through the capital market. Thus, during a state of equilibrium saving must equal investment. If there's any divergence between the 2, the equality is maintained through the mechanism of the rate of interest. To the classicists, interest is a reward for saving.
The higher is that the rate of interest, the upper the savings, and the other way around. On the contrary, the lower the rate of interest, the higher the demand for investment funds, and the other way around . If at any given time, investment exceeds saving, the rate of interest would rise.
Saving would increase and investment would decline till the 2 are equal at the complete employment level. This is often because saving is considered an increasing function of the rate of interest and investment a decreasing function of the speed of interest. This helps establish the equilibrium condition of saving-investment equality.
The process of generation of the equality between saving and investment is shown in Figure 3.1 where SS is that the saving curve and II is that the investment curve. The 2 curves intersect at E where the rate of interest gets determined at the extent of Or and both saving and investment are adequate to OA. If there's a rise in investment, the investment curve shifts to the proper and is shown as it curve.
At the rate of interest or, investment is greater than saving. Consistent with the classical economists, the saving curve SS remains at its original level when there's any increase in investment. To take care of the equality between saving and investment, the rate of interest will rise.
This is shown within the figure to rise from Oe to Or’. At this rate of interest, the saving curve SS intersects the investment curve IT at E’. Consequently, both saving and investment equal the quantity shown as OB. Thus whatever is saved gets invested through rate of interest flexibility.
The Quantity Theory of money and Price Level:
The validity of Say’s Law in a money economy directly depends on the classical quantity theory of money which states that the general price level changes directly and proportionately to the supply of money. Algebraically stated the idea states that MV = PT where M, V, P and 7′ are the availability of cash, velocity of money, price level and therefore the volume of transactions. The equation tells that the entire money supply MV equals the entire value of output PT within the economy.
Assuming V (the velocity of money) and T (the total output) to be constant, a change within the supply of cash (AY) causes a proportional change within the price level (P). This is often based on the belief that money acts only as a medium of exchange.
Let us show the main idea behind the quantity theory of money and its working in an exceedingly competitive economy. The relation between quantity of money, total output and price level is shown in Figure 3.2 (A) where the worth level is taken on the horizontal axis and therefore the total output on the vertical axis. MV is that the money supply curve which could be a rectangular hyperbola.
This is because the equation MV = PT holds on all points of this curve. Given the output level OQ, there would be just one price level (OP) according to the quantity of money as shown by point m on the MV curve. If the quantity of money increases, the MV curve will shift to the right: let it's shown as Mt K curve. As a result, the price-level would rise from OP to OP given an equivalent level of output OQ.
Assuming that the velocity of money V remains the same, this rise in the price level is exactly proportional to the rise within the quantity of money, i.e., PP1 = mm1. Classical believed that workers answer the changes in real wage rate decide to supply more less labour and it's possible to see the money wage in keeping with a given real wage. This is often explained in Figure 3.2 (B), where WIP is that the real wage line or wage-price line. When the price level is OP. The cash wage is OW. When the price level rises to OP the money wage also rises to OW1 The wage-price combination OW1= OP1 is according to the full employment real wage level W/P of Figure 3.3 (A) which we've drawn below. The proportionality between money wages and real wages is ensured by the operation of the number theory.
SAY’S LAW OF MARKETS:
Say’s law of markets provides justification to the belief of full employment. Say’s law in its simplest form means supply creates its own demand. In a very barter economy, a good is produced with a purpose of exchanging it for another good. Thus, additional supply represents additional demand.
In a money economy, money is medium of exchange. When an element of production (say labour) is employed, it leads to the production of commodities on the one hand and generates income (in the shape of payments of the factor of production) on the opposite.
The income received is spent within the market on the purchase of goods. Thus, the employment of an element of production pays its own way because it increases income by an amount equal (in equilibrium conditions) to the quantity taken out of the income stream by way of selling its products.
Hence, Say’s law, which rules out the likelihood of general over-production and general unemployment, applies both in barter also as during a money economy.
Faith in Policy of Laissez-Faire:
Full employment is assured through the policy of laissez-faire or government non-intervention. Whenever there exists involuntary unemployment, it's due to the interference with the free working of the competitive system. Such interference can be in the sort of action by trade unions to raise wages, unemployment insurance, wage legislation, etc. Remove these obstructions, allow the natural working of the economic system, and therefore the unemployment will automatically end.
Explanation of Classical Theory of Employment:
The classical theory of employment relies on the belief of flexibility of wages, interest and prices. This means that wage rate, rate of interest and price level change in their respective markets consistent with the forces of demand and provide . Changes in these variables automatically adjust the economic system in such a way on ensure full employment.
The working of self- regulating mechanism under the classical system is often understood within the three markets of the economy.
1. Labour market,
2. Product market, and
3. Money market.
1. Labour Market:
According to the classical theory of employment, other things being constant, wage rate flexibility assures that, during a competitive market, full employment is provided and full employment output is produced.
Real wage rate is decided by the forces of demand and supply within the labour market. Demand for labour may be a negative function of real wage rate; demand for labour increases with a fall within the real wage rate and decreases with an increase within the real wage rate.
Supply of labour may be a positive function of real wage rate; supply of labour increases with an increase in the real wage rate and decreases with a fall within the real wage rate. Real wage rate is determined at the extent where demand for labour and provide of labour is equal. This level also represents full employment equilibrium level.
If there exists unemployment, the unemployed will compete for jobs and therefore the real wage rate will fall. A fall within the real wage rate will result in an increase within the demand for labour and decrease within the supply of labour. This may remove unemployment. Thus, flexibility of real wage rate ensures full employment.
According to the classical theory, unemployment is that the results of rigidly of wage structure and interference within the automatic working of the labour market. When government intervenes by recognising trade unions, passing minimum wage legislation, etc., and labour adopts monopolistic behaviour, wages are pushed up which result in unemployment.
Only flexibility of wages, under the conditions of perfect competition, can ensure full employment. In the words of Pigou, “With perfectly free competition…. There'll be at work a strong tendency for wage rates to be related to the demand that everyone is employed.”
In Figure-1 (A), DL is that the aggregate demand for labour curve and SL is that the aggregate supply of labour curve. Intersection of those two curves at point E determines the equilibrium real wage rate, (W/P), at full employment level ON. If real wage rate is maintained at a higher level, (W/P)1, supply of labour will exceed demand for labour by GH, which indicates the amount of unemployment. Labour market being competitive, unemployment of labour will reduce wage rate to the original equilibrium level, (W/P). This may remove unemployment and once again establishes full employment level ON.
2. Production Function:
At the full employment level, total output of the economy depends upon the nature of the technology, total output (Y) could be a function of the number of workers employed (N). The classical economists assume the operation of the law of diminishing returns.
In Figure-1 (B), Y = f (N) curve represents total production function. At the full employment level, ON, the corresponding full employment output is OY.
3. Product Market:
Maintenance of full employment level, consistent with Say’s law, requires that the whole of the income generated at financial condition level must be spent on the purchase of the whole of the output produced at that level. Total output comprises of consumer goods (C) and investment goods (I).
Again, total income is partly spent on consumer goods (C) and partly saved (S). Hence, the part of income which isn't consumed (i.e. S) must be spent on investment goods. The logic of this argument are often easily grasped with the help of the subsequent algebric expression.
Thus, saving-investment equality (S = I) gives the market clearing condition within the product market at full employment level. It assures that whole of full employment output within the product market will be purchased.
According to the classical economists, equality between saving and investment is led to through rate of interest flexibility. Saving may be a positive function of rate of interest; saving will be more at higher interest rate and less at lower rate of interest.
Investment may be a negative function of rate of interest; investment increases at low rate of interest and decreases at higher interest rate. The equilibrium rate of interest is determined at the extent where saving and investment are equal.
At this level whole of the full employment output is purchased. If saving exceeds investment, the rate of interest will fall. This may discourage saving and encourage investment, thus making saving and investment once again equal.
In Figure-2, S curve is that the saving curve and i is the investment curve. The 2 curves intersect at point E. The equilibrium rate of interest is Oi, where saving and investment are equal (i.e., iE). If community decides to extend saving at all levels of rate of interest, the saving curve will shift to the right to S1 curve.
Now at the original rate of interest Oi, saving exceeds investment by EE2 which indicates the amount of overproduction. As a results of this excessive saving, the rate of interest will fall, which on the one hand results in increase in investment and on the opposite hand tends to reduce saving. Eventually, the rate of interest will fall to Oi1 and yet again the equality between saving and investment is established at Point E1.
4. Money Market:
Irving Fisher’s equation of exchange, MV= PY, states that total expenditure on final goods and services (MV) is adequate to total value of output (PY). Consistent with the classical economists, the long- run rate of output of final goods and services (Y) remains constant at full employment level.
They also assume that velocity of money (V) is stable because the payment habits of the people change very slowly. Thus, Y and V being constant, the worth level (P) is decided by the supply of money (M) and there's a direct relationship between M and P; changes within the money supply result in proportional changes in the price level.
Keynes vehemently criticised the classical theory of employment for its unrealistic assumptions in his General Theory.
He attacked the classical theory on the subsequent counts:
(1) Under-employment Equilibrium:
Keynes rejected the basic classical assumption of full employment equilibrium within the economy. He considered it as unrealistic. He regarded full employment as a special situation. The general situation during a capitalist economy is one of underemployment.
This is because the capitalist society doesn't function according to Say’s law, and supply always exceeds its demand. We find millions of workers are prepared to work at the current wage rate, and even below it, but they do not find work.
Thus the existence of involuntary unemployment in capitalist economies (entirely ruled out by the classicists) proves that underemployment equilibrium may be a normal situation and full employment equilibrium is abnormal and accidental.
(2) Refutation of Say’s Law:
Keynes refuted Say’s Law of markets that supply always created its own demand. He maintained that each one income earned by the factor owners wouldn't be spent in buying products which they helped to produce.
A part of the earned income is saved and isn't automatically invested because saving and investment are distinct functions. So when all earned income isn't spent on consumption goods and some of it's saved, there leads to a deficiency of aggregate demand.
This results in general overproduction because all that's produced isn't sold. This, in turn, results in general unemployment. Thus Keynes rejected Say’s Law that supply created its own demand. Instead he argued that it had been demand that created supply. When aggregate demand rises, to fulfil that demand, firms produce more and employ more people.
(3) Self-adjustment not Possible:
Keynes didn't agree with the classical view that the laissez-faire policy was essential for an automatic and self-adjusting process of financial condition equilibrium. He pointed out that the capitalist system wasn't automatic and self-adjusting due to the non-egalitarian structure of its society. There are two principal classes, the rich and therefore the poor.
The rich possess much wealth but they do not spend the entire of it on consumption. The poor lack money to get consumption goods. Thus there's general deficiency of aggregate demand in reference to aggregate supply which results in overproduction and unemployment within the economy. This, in fact, led to the great Depression.
Had the capitalist system been automatic and self-adjusting, this could not have occurred. Keynes, therefore, advocated state intervention for adjusting supply and demand within the economy through fiscal and monetary measures.
(4) Equality of Saving and Investment through Income Changes:
The classicists believed that saving and investment were equal at the full employment level and in case of any divergence the equality was caused by the mechanism of rate of interest. Keynes held that the extent of saving depended upon the level of income and not on the rate of interest.
Similarly investment is decided not only by rate of interest but by the marginal efficiency of capital. a low rate of interest cannot increase investment if business expectations are low. If saving exceeds investment, it means people are spending less on consumption.
As a result, demand declines. There's overproduction and fall in investment, income, employment and output. It'll cause reduction in saving and ultimately the equality between saving and investment are going to be attained at a lower level of income. Thus it's variations in income instead of in rate of interest that bring the equality between saving and investment.
(5) Importance of Speculative Demand for Money:
The classical economists believed that money was demanded for transactions and precautionary purposes. They didn't recognise the speculative demand for money because money held for speculative purposes associated with idle balances.
But Keynes didn't agree with this view. He emphasised the importance of speculative demand for money. He acknowledged that the earning of interest from assets meant for transactions and precautionary purposes could also be very small at a low rate of interest.
But the speculative demand for money would be infinitely large at a low rate of interest. Thus the rate of interest won't fall below a particular minimum level, and therefore the speculative demand for money would become perfectly interest elastic. This is often Keynes ‘liquidity trap’ which the classicists did not analyse.
(6) Rejection of Quantity Theory of Money:
Keynes rejected the classical Quantity Theory of money on the ground that increase in money supply won't necessarily cause rise in prices. It's not essential that people may spend all extra money. They'll deposit it in the bank or save.
So the velocity of circulation of money (V) may slow down and not remain constant. Thus V within the equation MV = PT may vary. Moreover, an increase in money supply, may lead to increase in investment, employment and output if there are idle resources within the economy and the price level (P) might not be affected.
(7) Money not Neutral:
The classical economists regarded money as neutral. Therefore, they excluded the theory of output, employment and rate of interest from monetary theory. Consistent with them, the extent of output and employment and therefore the equilibrium rate of interest were determined by real forces.
Keynes criticised the classical view that monetary theory was break away value theory. He integrated monetary theory with value theory, and brought the idea of interest within the domain of monetary theory by regarding the rate of interest as a monetary phenomenon. He integrated the worth theory and therefore the monetary theory through the idea of output.
This he did by forging a link between the number of cash and therefore the price index via the speed of interest. As an example , when the number of cash increases, the speed of interest falls, investment increases, income and output increase, demand increases, factor costs and wages increase, relative prices increase, and ultimately the overall price index rises. Thus Keynes integrated monetary and real sectors of the economy.
(8) Refutation of Wage-Cut:
Keynes refuted the Pigovian formulation that a cut in money wage could achieve full employment in the economy. The biggest fallacy in Pigou’s analysis was that he extended the argument to the economy which was applicable to a selected industry.
Reduction in wage rate can increase employment in an industry by reducing costs and increasing demand. But the adoption of such a policy for the economy results in a reduction in employment. When there's a general wage-cut, the income of the workers is reduced. As a result, aggregate demand falls resulting in a decline in employment.
From the sensible view point also Keynes never favoured a wage cut policy. In times, workers have formed strong trade unions which resist a cut in money wage. They might resort to strikes. The resultant unrest in the economy would bring a decline in output and income. Moreover, social justice demands that wages shouldn't be cut if profits are left untouched.
(9) No Direct and Proportionate Relation between Money and Real Wages:
Keynes also didn't accept the classical view that there was a direct and proportionate relationship between money wages and real wages. Consistent with him, there's an inverse relation between the 2 . When money wages fall, real wages rise and the other way around.
Therefore, a reduction within the money wage wouldn't reduce the real wage, as the classicists believed, rather it might increase it. This is often because the money wage cut will reduce cost of production and prices by more than the previous .
Thus the classical view that fall in real wages will increase employment breaks down. Keynes, however, believed that employment might be increased more easily through monetary and fiscal measures instead of by reduction in money wage. Moreover, institutional resistances to wage and price reductions are so strong that it's impossible to implement such a policy administratively.
(10) State Intervention Essential:
Keynes didn't agree with Pigou that “frictional maladjustments alone account for failure to utilise fully our productive power.” The capitalist system is such left to itself it's incapable of using productive powerfully. Therefore, state intervention is necessary.
The state may directly invest to raise the extent of economic activity or to supplement private investment. It's going to pass legislation recognising trade unions, fixing minimum wages and providing relief to workers through social security measures.
“Therefore”, as observed by Dillard, “it is bad politics even if it should be considered good economics to object to labour unions and to liberal labour legislation.” So Keynes favoured state action to utilise fully the resources of the economy for attaining full employment.
(11) Long-Run Analysis Unrealistic:
The classicists believed within the long-run full employment equilibrium through a self-adjusting process. Keynes had no patience to wait for the long period for he believed that “In the long-run we are all dead”.
As pointed by Schumpeter, “His philosophy of life was essentially a short-term philosophy.” His analysis is confined to short-run phenomena. Unlike the classicists, he assumes tastes, habits, techniques of production, supply of labour, etc. to be constant during the short period then neglects long-run influences on demand.
Assuming consumption demand to be constant, he lays emphasis on increasing investment to get rid of unemployment. But the equilibrium level so reached is one among underemployment instead of full employment. Thus the classical theory of employment is unrealistic and is incapable of solving this day economic problems of the capitalist world.
Keynesian Theory of Employment
As per Keynes theory of employment, effective demand signifies the money spent on the consumption of goods and services and on investment.
The total expenditure is adequate to the national income, which is similar to the national output.
Therefore, effective demand is adequate to total expenditure as well as national income and national output.
The theory of Keynes was against the assumption of classical economists that the market forces in capitalist economy adjust themselves to achieve equilibrium. He has criticized classical theory of employment in his book. Vie General Theory of Employment, Interest and Money. Keynes not only criticized classical economists, but also advocated his own theory of employment.
His theory was followed by several modern economists. Keynes book was published post-Great Depression period. The great Depression had proved that market forces cannot attain equilibrium themselves; they have an external support for achieving it. This became a significant reason for accepting the Keynes view of employment.
The Keynes theory of employment was based on the view of the short run. Within the short run, he assumed that the factors of production, like capital goods, supply of labour, technology, and efficiency of labour, remain unchanged while determining the level of employment. Therefore, consistent with Keynes, level of employment depends on national income and output.
In addition, Keynes advocated that if there's an increase in national income, there would be an increase in level of employment and the other way around. Therefore, Keynes theory of employment is additionally called theory of employment determination and theory of income determination.
Principle of Effective Demand:
The main point associated with starting point of Keynes theory of employment is that the principle of effective demand. Keynes propounded that the extent of employment within the short run depends on the aggregate effective demand of products and services.
According to him, a rise in the aggregate effective demand would increase the level of employment and vice-versa. Total employment of a country are often determined with the help of total demand of the country. A decline in total effective demand would result in unemployment.
As per Keynes theory of employment, effective demand signifies the money spent on the consumption of goods and services and on investment. The entire expenditure is adequate to the national income, which is like the national output. Therefore, effective demand is adequate to total expenditure also as national income and national output.
The effective demand is often expressed as follows:
Effective demand = national income = National Output
Therefore effective demand affects employment level of a country, national income, and national output. It declines because of the mismatch of income and consumption and this decline cause unemployment.
With the increase in the national income the consumption rate also increases, but the rise in consumption rate is comparatively low as compared to the increase in national income. Low consumption rate leads to a decline in effective demand.
Therefore, the gap between the income and consumption rate should be reduced by increasing the number of investment opportunities. Consequently, effective demand also increases, which further helps in reducing unemployment and bringing full employment condition.
Moreover, effective demand refers to the total expenditure of an economy at a specific employment level. The total equal to the total supply price of economy (cost of production of products and services) at a precise level of employment. Therefore, effective demand refers to the demand of consumption and investment of an economy.
Determination of Effective Demand:
Keynes has used two key terms, namely, aggregate demand price and aggregate supply price, for determining effective demand. Aggregate demand price and aggregate supply price together contribute to determine effective demand, which further helps in estimating the extent of employment of an economy at a specific period of time.
In an economy, the employment level depends on the number of workers that are employed, in order that maximum profit are often drawn. Therefore, the employment level of an economy depends on the choices of organizations associated with hiring of employee and placing them.
The level of employment is often determined with the assistance of aggregate supply price and aggregate demand price. Let us study these two concepts in detail.
Aggregate Supply Price:
Aggregate supply price refers to the total amount of money that all organizations in an economy should receive from the sale of output produced by employing a particular number of workers. In simpler words, aggregate supply price is that the cost of production of products and services at a specific level of employment.
It is the total amount of money paid by organizations to the different factors of production involved within the production of output. Therefore, organizations would not employ the factors of production until they will recover the cost of production incurred for employing them.
A certain minimum amount of price is required for inducing employers to offer a particular amount of employment. According to Dillard, “This minimum price or proceeds, which can just induce employment on a given scale, is named the mixture supply price of that amount of employment.”
If a corporation doesn't get an adequate price so that cost of production is covered, then it employs less number of workers. Therefore the aggregate supply price varies consistent with different number of workers employed. So, aggregate supply price schedule Id Tut can be prepared as per the total number of workers employed.
Aggregate supply price schedule is a schedule of minimum price required to induce the different quantities of employment. Thus, higher the price required to induce the various quantities of employment, greater the extent of employment would be. Therefore, the slope of the aggregate supply curve is upward to the right.
Aggregate Demand Price:
Aggregate demand price is different from demand for products of individual organizations and industries. The demand for individual organizations or industries refers to a schedule of quantity purchased at different levels of price of one product.
On the hand, aggregate demand price is that the total amount of money that a company expects to receive from the sale of output produced by a particular number of workers. In other words, the mixture demand price signifies the expected sale receipts received by the organization by employing a particular number of workers.
Aggregate demand price schedule refers to the schedule of expected earnings by selling the product at different level of employment Mo higher the level of employment, greater the level of output would be.
Consequently, the rise within the employment level would increase the mixture demand price. Thus, the slope of aggregate demand curve would be upward to the right. However, the individual demand curve slopes downward.
The basic difference between the aggregate supply price and aggregate demand price should be analyzed carefully as both of them seem to be same. In aggregate supply price, organizations should receive money from the sale of output produced by employing a specific number of workers.
However, in aggregate demand price, organizations expect to receive from the sale of output produced by a particular number of workers. Therefore, in aggregate supply price, the amount of money is the necessary amount that ought to be received by the organization, while in aggregate demand price the amount of money may or might not be received.
Determination of Equilibrium Level of Employment:
The aggregate demand price and aggregate supply price help in determining the equilibrium level of employment.
The aggregate demand (AD) and aggregate supply (AS) curve are used for determining equilibrium level of employment, as shown in Figure-3:
In Figure-3, AD represents the aggregate demand curve, while AS represents the aggregate supply curve. It are often interpreted from Figure-3 that although the aggregate demand and aggregate supply curve are moving in a similar direction, but they're not alike. There are different aggregate demand price and aggregate supply price for different levels of employment.
For example, in Figure-3, at AS curve, the organization would employ ON1 number of workers, once they receive OC amount of sales receipts. Similarly, just in case of AD curve, the organization would use ON1 number of workers with the expectation that they might produce OH amount of sales receipt for them.
The aggregate demand price exceeds the aggregate supply price or the other way around at some levels of employment. For instance , at ON1 employment level, the aggregate demand price (OH) is bigger than the aggregate supply price (OC). However, at certain level of employment, the mixture demand price and aggregate supply price become equal.
At this point, aggregate demand and aggregate supply curve intersect one another. This point of intersection is termed because the equilibrium level of employment. In Figure-3, point E represents the equilibrium level of employment because at now, the aggregate demand curve and aggregate supply curve intersect one another.
In Figure-3, initially, there's a slow movement within the AS curve, but after a certain point of time it shows a sharp rise. This implies that when a number of workers increases initially, the cost incurred for production also increases but at a slow rate. However, when the amount of sales receipt increases, the organization starts employing more and more workers. In Figure-3, the ON1 numbers of workers are employed, when OT amount of sales receipts are received by the organization.
On the opposite hand, the AD curve shows a rapid increase initially, but after a while it gets flattened. This suggests that the expected sales receipts increase with a rise in the number of workers. As a result, the expectations of the organization to earn more profit increase. As a result, the organizations start employing more workers. However, after a precise level, the rise in employment level wouldn't show a rise in the amount of sales receipts.
In Figure-3, before reaching the utilization level of ON2, the employment level keeps on increasing because the organizations want to higher more and more workers to urge the maximum profit. However, when the employment level crosses the ON21 level, the AD curve is below the AS curve, which shows that the aggregate supply price exceeds the mixture demand price. As a result, the organization would start incurring losses; therefore would reduce the employment rate.
Thus, the economy would be in equilibrium when the aggregate supply price and aggregate demand price become equal. In other words, equilibrium is achieved when the amount of sales receipt necessary and therefore the amount of sales receipt expected to be received by the organization at a specified level of employment are equal.
REFERENCES
1. Www.wikipedia.org
2. Www.economicsdiscussion.net
3. Macro economics - manan prakashan