The classical economists believed that there would always be full employment of resources i.e. the land, labor, capital and organization, in laissez fair economy, and this was said to be a normal situation. Another strong belief of the classical economists was that there would be lapses from full employment at certain times due to the establishment of monopolies and by govt, intervention in the economic life of the people. However, they added that despite this handicap, tendency to resort full employment will always exist. Hence, according to the classical economists, such a thing as unemployment and over production does not exist in a free economy. Thus, according to this theory, if the employment level goes up in one firm or industry under the situation of full employment, it would result in the employment level of another firm or industry going down. Similarly, if the production level in one industry rises, it falls in the other due to the given level of resources in the economy. Hence there exists no question of unemployment and no question of over production. This simply means that the classical economists believe that the laissez fair economy is always static at full employment level; instead of being dynamic.

This proposition of the classical economists rests on the plea that national income is spent automatically at a rate which will always keep the resources fully employment. Savings, according to classical, be just another form of spending; national income, they believe, is in large part spent on consumption and the rest on investment. Therefore, there is no ground to fear about any obstruction in the flow of income stream in the economy. Hence, there cannot be any general over-production or general unemployment.

As the saving goes “Money burns holes in people’s pockets,” some money is spent on consumer goods and the rest of it is saved and invested. Either way it goes it still is a form of expenditure. Saving is converted into investment in three ways.

(1) Purchasing capital goods.
(2) Buying bonds.
(3) Putting money in the saving accounts of banks.

Classical economists believe that there is always full employment in the country for which sufficient amount of saving and investment is automatically generated. The natural rate of interest is the mechanism which brings about the equilibrium between employment saving and investment. (We know that the saving function is always positively correlated with the rate of interest and the investment function is negatively correlated with the rate of interest).

According to the classical economists, if at a certain time investment falls short of savings, it results in the rate of interest to fall. This induced investment and thus the equilibrium is restored again.

According to the classical economists, when investment falls short of full employment savings, demand for consumer goods also falls due to excess savings. Thus, entrepreneurs shift their resources to capital goods industries to avoid losses due to which investment increases to be equal to the full employment savings. However, this theory may not prove to be sure because a fall in demand for consumer goods will lead to a fall of aggregate demand in the economy. Hence, investment will fall instead of rising.

Lord Keynes believed that as a result of a higher rate of interest, investment squeezes and consequently national income falls. Out of lower level of national income less saving would be generated to equate with the lower level of investment. Hence, it is not necessary that savings would increase at a higher rate of interest as indicated by classical economists.