C L AS S I CA L A N D K E Y N E S I A N E CO N O M IC E X P LA NAT I O N S FO R U N E M P LOY M E N T Michael Griffiths 5/12/2007 Prof. Roy Rotheim EC103: Introduction to Macroeconomics
Classical and Keynesian Economic Explanations for Unemployment Introduction Unemployment is a key measure of economic health. It is a major factor in determining how healthy an economy is; if the economy maximized efficiency, everyone would be employed at some wage. An individual unemployed is both unproductive and a drain on society’s resources. However, while unemployment seems a basic statistic – the number without jobs divided by those with jobs – the issue is anything but. Unemployment is a powerful statistic that shapes government policy and personal decisions. The government keeps a close eye on the unemployment rate. Not only does unemployment indicate that the economy isn’t operating at peak efficiency, but politicians have noticed that high unemployment correlates with losing elections. The Federal Reserve believes that unemployment below a certain threshold they refer to as the natural rate of unemployment leads to inflation, reflecting an observation by the economist A. W. Philips correlating unemployment to inflation during the 1960s. The Bureau of Labor Statistics is the US agency that monitors and reports on unemployment and other labor statistics. In 2006, the average unemployment rate was 4.6%1. This number only includes a subset of the total US population: the currently unemployed people who are willing and able to work. This subset of the population excludes children and infants, people in the prison system, and people who choose, for various reasons, not to work. Choosing to measure unemployment this way assumes that a classical free 1
market perspective works. That is, people making free choices will inevitably lead to the best outcome; everyone who wants a job will receive a job. In that sense, it is pointless to measure people who are unable or unwilling to work: if they wanted a job, they could get a job, and they evidently have a good reason not to work. This perspective envisions unemployment simply as the time spent between jobs; assuming people keep looking for a job, they will find one. John Maynard Keynes criticized this viewpoint as misleading. He pointed out that the people who drove demand for goods and services are the same people participating in the labor market. Unemployment means less income, which in turn means less demand; less demand causes the demand curve in the labor market to change, creating a feedback cycle. This paper will examine unemployment from both the classical and Keynesian perspective.
Classical Model of Unemployment
Under the classical perspective, …unemployment is seen as a sign that smooth labor market functioning is being obstructed in some way. The Classical approach assumes that markets behave as described by the idealized supply-anddemand model… (Goodwin 12) This paper will present a basic model of a labor market under the classical perspective. This model will treat both labor supply and demand independently, and assumes that the market exists in
Bureau of Labor Statistics
Economics | Prof. Roy Rotheim
Classical and Keynesian Economic Explanations for Unemployment isolation. While the labor market may experience external shocks, the labor market does not depend on exterior circumstances. This paper will then use the presented model to explain how unemployment works under a classical perspective. Furthermore, we will assume that this example occurs in the short term and thus revenue per product sold, wage per worker, and cost per unit of capital are all constant. Thus, we can express this as a function P (n, i, m) that describes profit: (1) P(n, i, m)
Classical Labor Demand
The demand for labor in the entire economy is simply the aggregate demand for labor from each company. It follows that the behavior...
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