ECS4861 Assignment 3
(COMPLETE ANSWERS)
2025 - DUE 13 August 2025
For assistance contact
Email:
, An Analysis of the Statement: "Wage and Price Rigidities are Needed for Keynesian Economics
to Explain Involuntary Unemployment"
The contention that wage and price rigidities are needed so that Keynesian
economics can explain involuntary unemployment is the fundamental point of
contention in macroeconomic theory. While classical school contends that wages and prices
will, naturally, restore a full-employment equilibrium, Keynesian
economics disagrees with this contention. However, how far wage and price rigidities
are conceived as a necessary condition for involuntary unemployment to be accounted
for varies substantially among different schools of thought within
Keynesianism. Close examination of the above statement requires step-by-step examination of
John Maynard Keynes's initial General Theory, subsequent orthodox Keynesianism, and modern
New Keynesianism. This conversation reveals that while Keynes himself thought the wage and
price rigidity as much a simplification assumption as anything else, rather than
the underlying cause, later schools of thought more and more began to regard them as the sine
qua non for creating permanent unemployment in their models.
Keynes's chief argument for involuntary unemployment in his masterpiece, The General Theory
of Employment, Interest and Money (1936), did not rely on wage and price stickiness.
He characterized involuntary unemployment as a state of affairs when individuals would accept a
job at a wage less than that prevailing, but no such jobs are available. His primary criticism of
classical economics was that it failed to reflect the aspect of aggregate demand,
or "effective demand" in his terminology. Keynes believed that employment is determined by
the level of spending in the economy. When there is insufficient effective
demand, companies will not be induced to work at full capacity, and hence they will lay off
workers, which creates unemployment. This deficiency in demand is not self-correcting.
Keynes addressed directly against the
classical solution that reducing wages would eliminate unemployment. A general decrease in
money wages would not by itself increase employment, he
argued. Though a decrease in wages would lower the production costs of a company, it would
also lower the workers' pay and hence their consumption, as well as aggregate demand. The
effect of a decrease in wages on the real wage and aggregate demand is
therefore uncertain. He further stated that a uniform cut in wages would increase the real burden
of debt, having a tendency to lower confidence and investment even further. Consequently,
Keynes believed that even under a perfectly flexible wage economy, involuntary unemployment
could endure due to a fundamental deficiency in effective demand. Keynes considered that the
root cause lay in the deficiency of spending that could result in a low-level equilibrium
trap rather than the failure of wages to flex. So for Keynes's General Theory, wage stickiness was
not a condition that must be met to produce involuntary unemployment; it was instead a realistic
feature of an economy unable to self-correct.
The orthodox Keynesian school that emerged in the decades following The General Theory
and which was best summarized by the IS-LM model took a different perspective. This school
(COMPLETE ANSWERS)
2025 - DUE 13 August 2025
For assistance contact
Email:
, An Analysis of the Statement: "Wage and Price Rigidities are Needed for Keynesian Economics
to Explain Involuntary Unemployment"
The contention that wage and price rigidities are needed so that Keynesian
economics can explain involuntary unemployment is the fundamental point of
contention in macroeconomic theory. While classical school contends that wages and prices
will, naturally, restore a full-employment equilibrium, Keynesian
economics disagrees with this contention. However, how far wage and price rigidities
are conceived as a necessary condition for involuntary unemployment to be accounted
for varies substantially among different schools of thought within
Keynesianism. Close examination of the above statement requires step-by-step examination of
John Maynard Keynes's initial General Theory, subsequent orthodox Keynesianism, and modern
New Keynesianism. This conversation reveals that while Keynes himself thought the wage and
price rigidity as much a simplification assumption as anything else, rather than
the underlying cause, later schools of thought more and more began to regard them as the sine
qua non for creating permanent unemployment in their models.
Keynes's chief argument for involuntary unemployment in his masterpiece, The General Theory
of Employment, Interest and Money (1936), did not rely on wage and price stickiness.
He characterized involuntary unemployment as a state of affairs when individuals would accept a
job at a wage less than that prevailing, but no such jobs are available. His primary criticism of
classical economics was that it failed to reflect the aspect of aggregate demand,
or "effective demand" in his terminology. Keynes believed that employment is determined by
the level of spending in the economy. When there is insufficient effective
demand, companies will not be induced to work at full capacity, and hence they will lay off
workers, which creates unemployment. This deficiency in demand is not self-correcting.
Keynes addressed directly against the
classical solution that reducing wages would eliminate unemployment. A general decrease in
money wages would not by itself increase employment, he
argued. Though a decrease in wages would lower the production costs of a company, it would
also lower the workers' pay and hence their consumption, as well as aggregate demand. The
effect of a decrease in wages on the real wage and aggregate demand is
therefore uncertain. He further stated that a uniform cut in wages would increase the real burden
of debt, having a tendency to lower confidence and investment even further. Consequently,
Keynes believed that even under a perfectly flexible wage economy, involuntary unemployment
could endure due to a fundamental deficiency in effective demand. Keynes considered that the
root cause lay in the deficiency of spending that could result in a low-level equilibrium
trap rather than the failure of wages to flex. So for Keynes's General Theory, wage stickiness was
not a condition that must be met to produce involuntary unemployment; it was instead a realistic
feature of an economy unable to self-correct.
The orthodox Keynesian school that emerged in the decades following The General Theory
and which was best summarized by the IS-LM model took a different perspective. This school
