a) Evaluating Wage and Price Rigidity in Keynesian Economics
Keynes’s General Theory
Understanding Involuntary Unemployment
John Maynard Keynes’s General Theory of Employment, Interest, and Money (1936)
posits that involuntary unemployment arises when the aggregate demand for goods
and services is insufficient to fully employ all individuals willing to work at current
wage rates. Keynes argues that unemployment results from a lack of effective
demand rather than from rigidities in wages or prices. For instance, during the Great
Depression, Keynes observed that despite potential downward adjustments in
wages, unemployment remained persistently high. This observation supports the
notion that insufficient aggregate demand, rather than wage rigidity alone, was the
primary driver of unemployment (Keynes, 1936).
Impact of Wage and Price Rigidity
Keynes acknowledged that wages could be "sticky," meaning they do not easily
adjust downward, which could contribute to unemployment. This stickiness might
occur due to factors like labor contracts, minimum wage laws, and social norms
which resist wage cuts. For example, during the 1930s, many businesses were
reluctant to lower wages due to the potential negative impact on worker morale and
productivity, even though this flexibility might have theoretically reduced
unemployment.
However, Keynes’s central argument focuses on the insufficiency of aggregate
demand rather than rigidities per se. Price rigidity, where prices do not adjust quickly
to changes in supply and demand, can also affect unemployment by preventing the
economy from adjusting to shocks. For instance, if prices are sticky and do not fall in
response to decreased demand, businesses may cut back on production and lay off
workers, exacerbating unemployment. This phenomenon was evident during periods
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