ECS4861
ASSIGNMENT 3 2025
UNIQUE NO.
DUE DATE: 13 AUGUST 2025
, Wage and Price Rigidities in an Economy
Introduction
In macroeconomic theory, the existence of involuntary unemployment—where
individuals are willing to work at the prevailing real wage but cannot find employment—
poses a central challenge to the classical assumption of market self-correction.
Keynesian economics emerged as a response to the Great Depression, emphasizing
the insufficiency of aggregate demand and questioning the ability of flexible wages and
prices to restore full employment. Wage and price rigidities, also known as nominal
stickiness, refer to the resistance of wages and prices to adjust downward in response
to economic shocks (Blanchard & Johnson, 2017). The purpose of this essay is to
evaluate the statement that “wage and price rigidities are necessary for Keynesian
economics to explain involuntary unemployment,” with reference to Keynes’s General
Theory, the orthodox Keynesian school, and New Keynesian economics.
Keynes’s General Theory
John Maynard Keynes’s The General Theory of Employment, Interest and Money
(1936) revolutionized macroeconomics by rejecting the classical notion that labor
markets always clear through flexible wages and that “supply creates its own demand”
as stated by Say’s Law. Keynes argued that unemployment can persist due to deficient
aggregate demand, even if markets are allowed to adjust.
While Keynes acknowledged that money wages are sticky downward due to labor
contracts, union resistance, and psychological factors, he did not consider wage rigidity
the fundamental cause of involuntary unemployment. Rather, the critical factor was the
insufficiency of aggregate demand: when investment falls, output and employment
decline because firms do not expect sufficient sales to justify hiring (Keynes, 1936).
ASSIGNMENT 3 2025
UNIQUE NO.
DUE DATE: 13 AUGUST 2025
, Wage and Price Rigidities in an Economy
Introduction
In macroeconomic theory, the existence of involuntary unemployment—where
individuals are willing to work at the prevailing real wage but cannot find employment—
poses a central challenge to the classical assumption of market self-correction.
Keynesian economics emerged as a response to the Great Depression, emphasizing
the insufficiency of aggregate demand and questioning the ability of flexible wages and
prices to restore full employment. Wage and price rigidities, also known as nominal
stickiness, refer to the resistance of wages and prices to adjust downward in response
to economic shocks (Blanchard & Johnson, 2017). The purpose of this essay is to
evaluate the statement that “wage and price rigidities are necessary for Keynesian
economics to explain involuntary unemployment,” with reference to Keynes’s General
Theory, the orthodox Keynesian school, and New Keynesian economics.
Keynes’s General Theory
John Maynard Keynes’s The General Theory of Employment, Interest and Money
(1936) revolutionized macroeconomics by rejecting the classical notion that labor
markets always clear through flexible wages and that “supply creates its own demand”
as stated by Say’s Law. Keynes argued that unemployment can persist due to deficient
aggregate demand, even if markets are allowed to adjust.
While Keynes acknowledged that money wages are sticky downward due to labor
contracts, union resistance, and psychological factors, he did not consider wage rigidity
the fundamental cause of involuntary unemployment. Rather, the critical factor was the
insufficiency of aggregate demand: when investment falls, output and employment
decline because firms do not expect sufficient sales to justify hiring (Keynes, 1936).
