Classical Theory of employment is related to classical economists such as David Ricardo, J.S. Mill, A.C. Pigou. This theory is based on the assumption of full employment of factors of production without inflation. According to this law, there are automatic forces that tend to maintain full employment and produce output at that level. This theory is based on various assumptions they are as follows:
(1) There is existence of full employment. Full employment means all factors of production are employed except voluntary, unemployment, but there is no any type of inflation.
(2) There is closed laissez faire capitalist economy. This theory assumes free market economy, but there is no foreign trade.
(3) There is perfect competition in product market as well as factor market. Factor market is labour market.
(4) Labour is homogeneous. All labourer possesses perfectly equal quality and productivity.
(5) National income is divided among consumption and investment expenditure.
(6) The quantity of money is given.
(7) Wages and prices of product are flexible.
(8) Money wage and real wage are proportional and directly related.
(9) Capital stock and technological knowledge are given in short period of time.
(10) Function of money is only medium of exchange.
This theory assumes flexibility of wages, interest and prices. It means that prices of products, interest rate and wage rage depend upon relative force of demand and supply for them changes in there variables automatically adjust the economic system in such a way that economy holds the status of full employment.