Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

 
 
The aggregate supply schedule shows the quantity of output 
that firm wish to supply at different price level. The level of output 
depends on the level of employment of labour. 
Given the amount of capital goods, the demand for labour 
shows how much is demanded at different levels of real wage rate. 
Real wage is the nominal or money wage divided by price level. 
The labour demand schedule shows that demand for labour is 
higher if real wage is lower. 
When the real wages fall, marginal product of labour is 
higher than the real wage rate. Therefore, the firm will increase the 
employment. 
The labour supply curve sloped upwards because the supply 
of labour is higher when the real wage is higher. In other words, as 
the real wage rises, more people accept jobs. The equilibrium rate 
of wage is determined by the demand and supply of labour. 
 
FIGURE 9.4: LABOUR MARKET 
0
Labour
RealWage
s
L
d
L
0
w
1
w
K
F
0
N
E

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The labour market equilibrium takes place at wage rate w
0
where employment is N
0
. At higher wage rate such as W
1
, labour 
supply is greater than the labour demand by KF and this pushes 
the wage down to equilibrium level. The opposite is true if the wage 
rate is lower than the equilibrium level. 
In the Classical model, labour market is always in equilibrium 
at full employment because there is automatic change in price and 
money wage. In other words, price and money wages are fully 
flexible so that labour market clears immediately. Therefore output 
remains constant at full employment level. 
However at full employment level, there is voluntary 
unemployment which is taken as the natural rate of employment. If 
the current unemployment rate is equal to the natural rate of 
unemployment then country is at full employment. 
The final step on supply side is to connect employment, 
output and prices. In the Classical model, employment is always at 
full employment level as the money wage and price adjust 
immediately so as to keep the real wage constant. 
Hence full employment level of output remains same at 
different levels of price. For instance, if money wages rises, the 
price also rises immediately and real wage remain the same.
On the other hand, if price level fall, money wages also will fall and 
real wage remains same. 

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