ECS4861
ASSIGNMENT 3 2025
UNIQUE NO.
DUE DATE: 13 AUGUST 2025
, Advanced Macroeconomics
Wage and Price Rigidities and Involuntary Unemployment in Keynesian
Economics
Introduction
The persistence of involuntary unemployment remains one of the core concerns of
macroeconomic theory and policy. Keynesian economics, diverging from classical
models that assume wage and price flexibility ensures full employment, introduces the
notion of rigidities as critical explanatory variables. The statement "Wage and price
rigidities are necessary for Keynesian economics to explain involuntary unemployment"
directly engages with foundational and evolving theories in the Keynesian tradition. This
essay evaluates the accuracy and relevance of this assertion by examining three
strands of Keynesian thought: Keynes's original theory, the orthodox Keynesian school,
and New Keynesian economics. Each theoretical perspective is analyzed to determine
the extent to which wage and price rigidities are essential to explaining involuntary
unemployment.
1. Keynes's General Theory and Wage-Price Rigidities
John Maynard Keynes's seminal work, The General Theory of Employment, Interest
and Money (1936), revolutionized economic thinking by rejecting the classical
assumption that markets, including labor markets, always clear. Keynes argued that
involuntary unemployment could persist even in the presence of rational agents,
primarily due to aggregate demand deficiencies. A key element in this framework is the
rigidity of wages and prices.
Keynes postulated that nominal wages tend to be downwardly inflexible. Workers resist
nominal wage cuts due to money illusion and concerns over fairness. Employers,
fearing declines in worker morale and productivity, are reluctant to reduce nominal
wages even in the face of excess labor supply. This wage stickiness prevents the labor
market from adjusting to shocks, thus leading to involuntary unemployment. Prices are
ASSIGNMENT 3 2025
UNIQUE NO.
DUE DATE: 13 AUGUST 2025
, Advanced Macroeconomics
Wage and Price Rigidities and Involuntary Unemployment in Keynesian
Economics
Introduction
The persistence of involuntary unemployment remains one of the core concerns of
macroeconomic theory and policy. Keynesian economics, diverging from classical
models that assume wage and price flexibility ensures full employment, introduces the
notion of rigidities as critical explanatory variables. The statement "Wage and price
rigidities are necessary for Keynesian economics to explain involuntary unemployment"
directly engages with foundational and evolving theories in the Keynesian tradition. This
essay evaluates the accuracy and relevance of this assertion by examining three
strands of Keynesian thought: Keynes's original theory, the orthodox Keynesian school,
and New Keynesian economics. Each theoretical perspective is analyzed to determine
the extent to which wage and price rigidities are essential to explaining involuntary
unemployment.
1. Keynes's General Theory and Wage-Price Rigidities
John Maynard Keynes's seminal work, The General Theory of Employment, Interest
and Money (1936), revolutionized economic thinking by rejecting the classical
assumption that markets, including labor markets, always clear. Keynes argued that
involuntary unemployment could persist even in the presence of rational agents,
primarily due to aggregate demand deficiencies. A key element in this framework is the
rigidity of wages and prices.
Keynes postulated that nominal wages tend to be downwardly inflexible. Workers resist
nominal wage cuts due to money illusion and concerns over fairness. Employers,
fearing declines in worker morale and productivity, are reluctant to reduce nominal
wages even in the face of excess labor supply. This wage stickiness prevents the labor
market from adjusting to shocks, thus leading to involuntary unemployment. Prices are
