ECS4861
Assignment 3 2026
Unique number:
Due date: 7 August 2026
Wage and Price Rigidities and Involuntary Unemployment: A Critical
Assessment of Keynes’s General Theory, Orthodox Keynesianism and
New Keynesian Economics
1. Introduction
The claim that wage and price rigidities are essential to a Keynesian explanation of
involuntary unemployment raises an important disagreement about what makes an
economic theory truly Keynesian. Involuntary unemployment exists when people are
willing and able to work at the current wage, yet firms do not provide enough jobs
because production and spending remain too low. Classical economics normally
assumes that flexible wages, prices and interest rates will move the economy
towards full employment, because lower wages should encourage firms to employ
additional workers. Keynes challenged this reasoning by arguing that employment
, Wage and Price Rigidities and Involuntary Unemployment: A Critical
Assessment of Keynes’s General Theory, Orthodox Keynesianism and New
Keynesian Economics
1. Introduction
The claim that wage and price rigidities are essential to a Keynesian explanation of
involuntary unemployment raises an important disagreement about what makes an
economic theory truly Keynesian. Involuntary unemployment exists when people are
willing and able to work at the current wage, yet firms do not provide enough jobs
because production and spending remain too low. Classical economics normally
assumes that flexible wages, prices and interest rates will move the economy
towards full employment, because lower wages should encourage firms to employ
additional workers. Keynes challenged this reasoning by arguing that employment
depends mainly on effective demand, which is strongly influenced by investment,
expectations, uncertainty, money and the interest rate (Keynes, 1937, pp. 217–221).
The orthodox Keynesian school later placed greater weight on fixed wages and
prices within its income expenditure and IS LM models, while New Keynesian
economics developed detailed reasons for slow wage and price adjustment
(Snowdon & Vane, 2005, pp. 54–75). This essay argues that rigidities are important
transmission mechanisms, particularly in orthodox and New Keynesian theory, but
they are not the deepest or only foundation of Keynes’s explanation of involuntary
unemployment (Tobin, 1993, pp. 46–48).
2. Involuntary Unemployment and Market Adjustment
Involuntary unemployment must be separated from frictional, structural and classical
unemployment because these forms arise from different economic conditions and
require different responses. Frictional unemployment develops while people move
between jobs, whereas structural unemployment appears when workers’ skills or
locations do not match available employment opportunities. Classical unemployment
may occur when the real wage is kept above the level that balances labour demand
and supply, possibly because of wage regulations, trade union power or other labour
market arrangements (Tobin, 1993, pp. 48–49). Keynesian unemployment is
different because firms employ fewer workers mainly because they cannot sell
Assignment 3 2026
Unique number:
Due date: 7 August 2026
Wage and Price Rigidities and Involuntary Unemployment: A Critical
Assessment of Keynes’s General Theory, Orthodox Keynesianism and
New Keynesian Economics
1. Introduction
The claim that wage and price rigidities are essential to a Keynesian explanation of
involuntary unemployment raises an important disagreement about what makes an
economic theory truly Keynesian. Involuntary unemployment exists when people are
willing and able to work at the current wage, yet firms do not provide enough jobs
because production and spending remain too low. Classical economics normally
assumes that flexible wages, prices and interest rates will move the economy
towards full employment, because lower wages should encourage firms to employ
additional workers. Keynes challenged this reasoning by arguing that employment
, Wage and Price Rigidities and Involuntary Unemployment: A Critical
Assessment of Keynes’s General Theory, Orthodox Keynesianism and New
Keynesian Economics
1. Introduction
The claim that wage and price rigidities are essential to a Keynesian explanation of
involuntary unemployment raises an important disagreement about what makes an
economic theory truly Keynesian. Involuntary unemployment exists when people are
willing and able to work at the current wage, yet firms do not provide enough jobs
because production and spending remain too low. Classical economics normally
assumes that flexible wages, prices and interest rates will move the economy
towards full employment, because lower wages should encourage firms to employ
additional workers. Keynes challenged this reasoning by arguing that employment
depends mainly on effective demand, which is strongly influenced by investment,
expectations, uncertainty, money and the interest rate (Keynes, 1937, pp. 217–221).
The orthodox Keynesian school later placed greater weight on fixed wages and
prices within its income expenditure and IS LM models, while New Keynesian
economics developed detailed reasons for slow wage and price adjustment
(Snowdon & Vane, 2005, pp. 54–75). This essay argues that rigidities are important
transmission mechanisms, particularly in orthodox and New Keynesian theory, but
they are not the deepest or only foundation of Keynes’s explanation of involuntary
unemployment (Tobin, 1993, pp. 46–48).
2. Involuntary Unemployment and Market Adjustment
Involuntary unemployment must be separated from frictional, structural and classical
unemployment because these forms arise from different economic conditions and
require different responses. Frictional unemployment develops while people move
between jobs, whereas structural unemployment appears when workers’ skills or
locations do not match available employment opportunities. Classical unemployment
may occur when the real wage is kept above the level that balances labour demand
and supply, possibly because of wage regulations, trade union power or other labour
market arrangements (Tobin, 1993, pp. 48–49). Keynesian unemployment is
different because firms employ fewer workers mainly because they cannot sell
