Pigou’s Version has given final touch to classical theory of employment, who formulated Say’s law in terms of labour market. According to Pigou, under free competition the tendency of economic system is to automatically provide full employment in labour market. Flexibility in wage rate assures equilibrium in labour market with full employment. Real wage rate is determined by the forces of demand and supply of labour in market. Demand for labour is negative function of real wage rate. In classical model of employment, changes in money wages and real wages are directly related and are proportional. Therefore, demand for labour increases with a fall in real wage rate and decreases with rise in real wage rate.
On the other hand, supply of labour is positive function of real wage rate. Supply of labour increases if wage rate increases and it decreases when wage rate falls. Wage rate is determined at the level where demand for labour and supply of labour are equal. This level of wage rate represents full employment equilibrium level. According to Pigou, “with perfectly free competition, there will always be at work a strong tendency for wage rates to be so related to demand that everybody is employed. He has given a equation to explain it
N = qY/W, here N is the number of workers employed, q is fraction of income earned as wages, Y is national income and W is money wage rate, N can be increased by reducing W. Thus, the key to full employment is a reduction in money wage. This is explained in following figures.
In above figure-(A), SL is supply of labour and DL is demand for labour. At point e, two curves interest each other, it is point of full employment. NF and the real wage wage w/p at which full employment is recurred. If the real wage increased at a higher level than w/p. Supply of labour exceeds the demand labour by TR. In this situation N1NF number of labours are unemployed. Unemployment dis-appears only when the wage is reduced to w/p level. Thus full employment is attained.
In lower figure-(B), MPL is marginal productivity of labour which slopes downward as more labour are employed. Since every labour is paid wages equal to its marginal product, therefore the full employment level NF is reached when the wage rate falls from w/p1 to w/p.