The term classical unemployment refers to the effect real wages and the market clearing wage has on the availability of jobs. Classical unemployment increases when real wages rise relative to the market clearing wage.
Also known as real-wage unemployment, increases and decreases in classical unemployment is a function of the law of supply and demand. Classical unemployment occurs when the wages a worker is willing to accept (real wages) is in excess of those an employer is willing to pay (market clearing wage). By definition, the market clearing wage is the equilibrium wage. That is to say, it is the wage at which the supply of labor is equal to the demand for labor. This relationship is illustrated below:
At the market clearing wage (MCW), the demand for labor is exactly equal to the supply of labor and classical unemployment would be zero. When real wages (RW) are in excess of the market clearing wage (MCW), classical unemployment is greater than zero.
A business is willing to pay $25,000 per year to workers on their assembly line. At this rate of wages, the value the worker brings to the business is in excess of $25,000, which allows the company to remain profitable. However, unemployed workers in the area are not willing to make less than $30,000 per year when working on the assembly line. Since the real wages workers are willing to accept (RW=$30,000) is higher than the wages the business is willing to pay (MCW=$25,000), classical unemployment exists.