Say’s law of markets is the core of the classical theory of employment.
An early 19th century French Economist, J.B. Say, enunciated the proposition that “supply creates its own demand.
Therefore, there cannot be general overproduction and the problem of unemployment in the economy.
If there is general overproduction in the economy, then some labourers may be asked to leave their jobs.
The problem of unemployment arises in the economy in the short run. In the long run, the economy will automatically tend toward full employment when the demand and supply of goods become equal.
When a producer produces goods and pays wages to workers, the workers, in turn, buy those goods in the market.
Thus the very act of supplying (producing) goods implies a demand for them. It is in this way that supply creates its own demand.
Determination of Output and Employment:
In the classical theory, output and employment are determined by the production function and the demand for labour and the supply of labour in the economy.
Given the capital stock, technical knowledge and other factors, a precise relation exists between total output and amount of employment, i.e., number of workers.
This is shown in the form of the following production function:
Q=f (K, T, N)
where total output (Q)
function (f) of
capital stock (K)
technical knowledge (T),
the number of workers (N)
Given K and T, the production function becomes Q = f (AO which shows that output is a function of the number of workers.
Output is an increasing function of the number of workers, output increases as the employment of labour rises. But after a point when more workers are employed, diminishing marginal returns to labour start.
This is shown in Fig. 1 where the curve Q = f (N) is the production function and the total output OQ corresponds to the full employment level N . But when more workers N N are employed beyond the full employment level of output OQ , the increase in output Q Q is less than the increase in employment N N .