Classical Theory of Unemployment
The Classical view of unemployment states that the economy will achieve full employment (the natural rate of unemployment) if wages and prices are flexible. This view attests that unemployment occurs when wages rise too high to maintain equilibrium. When wages go up, firms can’t afford to pay as many workers, so some may be laid off or fired, increasing unemployment. When this happens, fewer people have money to buy things so demand goes down and prices tend to go down. Because unemployment is high, more people are looking for work giving firms more choice in who they hire and for how much. This results in decreasing wages. The Classical view claims that the unemployment rate will always go through cycles, but in the end, will always correct itself to the natural unemployment rate.

Dr. Stephanie Powers,[ ECON101], Uneployment Notes, Winter 2012

  • In the long run, the economy will have full employment (natural rate of unemployment) if wages and prices are flexible
  • Unemployment results from wages and prices being too high
  • Business cycles are temporary, Markets are intrinsically stable.
  • A perfectly competitive market with no government intervention will correct itself
  • If aggregate spending (C+I+G+X-IM) is not sufficient to produce full employment then
    • Decrease in spending >PDOWN > Interest Rates DOWN > Loans UP ­> Spending ­UP
    • Unemployment UP ­> Competition for jobs > Wages DOWN > Unemployment DOWN
  • Say’s Law: Supply creates its own demand -[1]- Basis of the classical theory of unemployment - incorrectly attributed to french economists Jean Baptiste Say- Producing goods and services requires use of factors of production- Factor payments create income for households- Households purchase goods and services using there income
S.Powers, lecture notes, slide 43
  1. ^ Unemployment Lesson Notes ECON 101, Lecture, Red Deer College, Red Deer, AB, February 2012