|(i) The assumption of perfect competition and of the so-called 'law of increasing marginal costs'. The consequence of this assumption is the association of the rise in employment with a decline in real wages.|
|(ii) The assumption of a given general price level or a given value of the aggregate demand, from which it follows that real wages change in the same direction as money wages.|
Now, the cut in money wages being followed by a decline in real wages, and the latter being associated with a rise in employment, the reduction in money wages leads, according to the 'classical' theory, to an increase in employment.
Before a critical appreciation of these assumptions we shall describe them in some detail.
2. Let us start from the law of increasing marginal costs and perfect competition. Imagine an establishment with a given capital equipment which produces 100 units of a certain commodity. By increasing employment slightly it may produce 101 units. Now the additional cost of producing the 101st unit, consisting mainly of the cost of raw materials and wages, is called the marginal cost at the level of production equal to 101.
According to the 'law of increasing marginal costs', the marginal cost, i.e. the cost of producing the last unit, rises with the level of output obtained from a given capital equipment. This law will appear to many readers not too plausible, and rightly so: whereas in agriculture a disproportionately higher input of fertilizers and labour is required in order to increase the yield, in an industrial establishment the marginal cost starts to rise spectacularly only when maximum utilization of equipment is approached--which happens to be rather an exception.