hi guys my name is videe calvary and welcome back to my channel 5 minute economics where i teach economic concepts in a span of just 5 minutes the topic for today is classical theory of output income and employment before we go over there firstly a very big thank you because of you we just hit 20 000 subscribers on youtube and this is my first video after we hit the same so thank you thank you so much i'm more than happy for the same and keep the love coming so guys this video is a much requested video by many of you you always wanted this complicated model and today i am here for you so because this theory this model being a very complicated one i have divided this video into two parts i will be coming for the with the second part very soon but in today's video i'll be telling you all you need to about the classical theory the you know the features the capitalist economist the classical economist who believed in the classical theory actually we'll be discussing about the wage price flexibility model the interest rate flexibility model the goods market equilibrium the money market equilibrium that is all that you need to study the little little parts before you actually move to that classical big diagram so in the next video i'll be coming with that diagram along with the criticisms or the critique of this particular theory but you have to watch out this video plus there's one more video which i've already made on sales law so i would request you to watch that video because sales law is a very important part of the classical theory so i'll attach the link in the comment section below so yeah let's get started also guys don't forget to like this video and please subscribe to my channel in case you haven't already also follow me on instagram at five minute economics so firstly guys coming to the background of this particular theory of outward income and employment so this theory has been given two versions one the classical one the kinesion so you know coming back tracing to the history of macroeconomics we had two major schools of thought the classical and the nation now you would say yes neoclassical and monetarists are also there yes i totally agree but here we're going to talk absolutely about classical theory the classical economist who were the traditional economists they came in much before the kinesian economist and they rested their theories around a capitalist economy okay their functioning was their featuring whatever they had rested their case upon was on a capitalist economy who were they you know adam smith jp ricardo mill and all of that whereas venetian school we know jim keane's being done like the king of the kinesian theory obviously they all came in much later on so here we are talking about a capitalist economy so before we move ahead to the theory we need to learn a little background what is a capitalist economy you know why did they operate around this firstly it is a capitalist economy is that which is you know a lazosphere economy uh it's you know functioning on its own a cap that is called a capitalist economy ownership of means major major thing which you have to know is your private individuals are the kingpin they are the one who set up everything okay private individuals are doing all the work due to which now where private individuals are there it's just but obvious that profit maximization is the major goal right guys so here are a feature of the capitalist economy is profit maximization minimum role of government minimum role of state or government however you can say so state intervention is minimum uh who operates the economy the private individuals and their motive is profit maximization importance of free market mechanism so this is a very important point under capitalist economy on which uh you know the classical theorists they rested their case upon they said that you know this economy has an invisible hand which means it's obviously not there but they had this functioning this thing that if economy is left to its own self there will be an invisible hand which will come in and you know if there is any disequilibrium it will settle so if there is unemployment and in invisible hand you know the market forces of demand and supply will operate and ultimately we will come back to the situation of employment however this was refuted highly criticized by the kinesian economist much later on but yes they rested their theory upon this background and lastly here guys money money under classical economics was look only as a transactionary purpose like medium of exchange for transaction though the speculative uh you know motive the store of value of money motive was kind of ignored so only medium of exchange was there so i hope you're clear with the features of a capitalist economy moving ahead guys let us study the belief of ce that is the classical economist i've written it in short so one major thing which i just told you is that they believed in the invisible working right invisible hand they believe a hand will come in government is not going to intervene and everything will come back to normal that's what their belief was seeing now we would say they were mad but at that time they were the first people who actually brought this theory when there was nothing so that is the basis of that theory you know on the basis of that theory we have so many further theories and that's why even it being highly criticized we still study this theory so firstly guys i just told you that their major belief was a free market mechanism as in this invisible hand there was free market there is no one who is actually going to force what's going to happen in the market the demand and supply are left to itself that is what they believe in secondly they had this probably they were very optimistic people i would say they always said that you know an economy will be at full employment level whereas you know later on you will see me talking about the same thing that kinisian economist highly criticized it they said full employment full employment is a rare phenomena second phenomena can you imagine there is a situation where all the people in our country are employed like is it even possible no right so full employment is a very rare phenomenon according to kinesian economist so let's keep that part aside i will make a theory on keane's also a video on the keems theory also later on but for now let's focus what classical said they said an economy always stems towards full employment and they automatically achieve full employment so first later he said we are at full employment in case we are also not at full employment we will always tend towards full employment the economy will move automatic adjustment will happen no state is going to intervene and intervene and we will reach full employment level so keith's further later on he came and criticized this and actually said his theory is based on the problem of on employment as well as the you know solutions to it so this is an entirely different thing which keane said but what classical said was yes classical economist had always best out the theory on the full employment level okay economy is at full employment so this is the belief you should know a belief of classical economics because further when we do the little little parts no you have to keep all these little things in mind only then can you join the dots of this also complicated theory so if you understand the micro level macro level you'll understand right moving ahead to the theory guys so let me just you know segregate it for those who are very confused what to study what to not to study in this theory so this theory have divided into four parts says law wage price flexibility model interest rate flexibility model also known as a goods market equilibrium and the money market equilibrium so i've made a separate video on sales law so in this video i'm not going to repeat the same thing i will attach the link in the comment section below says law that supply creates its own debunk have a look it's very important if you've done the sales law you've understood most of the classical theory we'll be further moving to wage price flexibility and interest rate flexibility models which are very important and lastly we'll be doing money market equilibrium in very brief because again i have made a video on quantity theory of money but this same thing has been discussed in very much detail so i'll attach the link for this particular video also in the comment section below so now guys moving to the wage price flexibility model of full employment so all eyes over here on the board so here guys as i just mentioned like 10 times before also that here classical economist thought that there is full employment always but if there is unemployment we will reach towards full employment how we are going to do that now so what do they say or what did they suggest that in case in case there is you know unemployment in the economy we should cut the wages of the people who are there in the you know who are working with us your argument is based on the assumption of money wage is equal to real you know the salary what you're getting like 50 000 a month what you're earning is your money wage real which you're there the inflation adjusted wages right purchasing power so here we've assumed money wages real weight that is the assumption i thought to actually draw like this rather than write it so that you can understand this flow chart method so number one thing what do we do if there is unemployment according to classical economics we will cut the wages up one when we cut the wages guys there is reduction in the cost of production isn't it like we are paying our labor for something and now we've cut down the wages of the labor now due to cutting out the you know wages the cost of production of that particular product what the laborers were producing has fallen isn't it think logically guys obviously the cost of production has reduced now cost of production has reduced due to which abujo good it is available at a cheaper price right so now the price of that good because of reduction in the cost of production has gone down and we know when there is a fall in price demand right profile and price leads to greater demand so this happens when there is a lower price the demand for the good is more the sales are pushed up now sales are pushed up so we need more people to you know produce the good we look chinese so in that case we will reach employment level so now if you feel you know one of my students actually told me mom it's very cliche this model you know but that time their thinking was this yes that you know cutting wages will lead to the cost of production being reduced lower prices ultimately pushing the sales and leading to employment and again what we are back to full employment level so this is what they actually thought later on actually qrikins criticized this point highly and do you think cutting wages in an economy like ours or you know any in economy it is easy like there are so many trade unions labor unions so cutting wages of people yeah people will revolt and we will ultimately never reach to what we plan to so this is the wage price flexibility model i hope you're clear with it further guys moving ahead to the goods market equilibrium also known as interest rate flexibility model in few books so however you can call it what does this particular part denotes that it shows us that you know the classical economist always said that savings equal to investment so that is the destination which we have to reach now let me take you through the path of it so what do they think they think that they thought was that savings and investment always equalize to each other it means whatever is you know uh whatever is not spent is saved and whatever is saved is subsequently invested it's unrealistic right we do tend to save a lot of things but we don't tend to always invest that money isn't it but they thought you'll be saving investment hoga here we have assumed that full employment is there obviously classical economic classical theory where total demand is equal to total supply what they said again here also they said savings and investment are always equal but in case you know savings and investment are not equal just how we assume just in case there is full uh unemployment in the wage price flexibility model which we just did so in case if they are not equal savings and investment then what will happen we will have a roi mechanism why that's why it's called interest rate you know because roi which is a king over here you know rate of interest both are the importance they are classical economists never actually again was refuted so along with this theory i'm teaching you little criticisms also uh keem's theory came that you know income problem importance media but this theory was based only on roi so they said in case there's any divergence between savings and investment roi will step in and then automatically savings will equalize to investment so here they have said that saving is a function of rate of interest and ie also investment is a function of rate of interest thus s is equal to i now two things in point number six and seven you have to understand that interest is a reward for saving isn't it when we save something we get an interest for it right higher is our i or roi whatever you can call it higher is the interest rate we will like to save more higher is the saving and obviously lower is the investment is if you're saving more investment come okay right one more thing which i always tell my students and i'm telling you guys also that i and i that a small i in economics rate of interest and capital i investment are always working in inversely proportional direction so if one is rising the other is falling remember that okay if you can't understand the logic memorize that then so lower eye that is lower interest of roi will lead to lower saving and of course when roi is less than higher will be the investment so these two points point number six and seven please understand it clearly now moving to this little diagram which i've drawn so that you know you can understand this model even better is this diagram where we have interest rate on the y-axis capital and all of that you know we are basically trying to show interest rate equality firstly we see this is our savings curve and this is our investment curve and they are uh intersecting at point e which is the equilibrium point where s is equal to i and r is our interest rate now uh due to some reason maybe our interest rate you know rises we've gone up so look at the red arrow which i've drawn we've gone up now we see guys at a higher rate of interest clearly savings are more you can see by a b i've drawn it here this a b is the excess of savings over investment and when the savings are more than the investment guys the rate of interest tends to fall making us come back to this e equilibrium level so again this black arrow is the second arrow first we go up then we are coming back to equilibrium level and again s is equal to i similarly guys if rate of interest by any chance tends to fall we've come to r double dash a little lower on the diagram we notice that here we see now again you can see cd is the excess of investment over saving now investment rather has saving come here in that case when investment is more than saving our roi tends to rise pushing us back to the equilibrium level which is e and we are back to s is equal to i point so basically this is what ce classical economist tended to prove us that if there is any divergence between savings and investment roi steps in and then we are back to our equilibrium position so the last part of this video i'm going to do very briefly which is the money market equilibrium why i'm doing briefly is because i've already made a video on the quantity theory of money which actually talks all about this so i'll attach the link i don't want you know a repetition in my videos for you and for me that's better so do watch out that video if you don't understand this here we have assumed in quantity theory of money mv is equal to pt is our equation you already should be knowing it and v and t are the constant things which is velocity and transaction cost money supply and price stand for m and p respectively what we are saying guys in this particular model is that what we are trying to prove is that a chain and supply of money causes an equi-proportional change in price so economy money supply price level but then that is what this theory is based upon this is a little diagram which you have drawn for your convenience here we have price we have output initially we see we are at mv level where this is our mv point and you know this is our output q and p's are priced due to some level our aggregate demand rises due to which the money supply increases due to which our demand curve shifts from mv to m dash v now we've shifted ahead now we see whatever is the increase in money supply from m to m dash same as the increase in price from p to p dash so that is what this theory is based upon money supply increase price economy may increase yoga so this is actually the money market equilibrium theory we are done with the little portions of the classical theory guys next video we'll be talking about the main major crux of the model as well as the criticisms of the classical theory so do wait for that till then do like this video and subscribe to my channel and i'll see you in the next video pretty soon [Music]