Keynes’s main attack against the postulates of the classical economists centres around the relationship between price flexibility and full employment. Keynes challenged the classical belief that price flexibility can be relied upon to generate automatic full employment. The defenders of the classical school, on the other hand, still insist upon this automaticity as a fundamental tenet.

Oct 01, 2010 We analyze the transmission mechanism of wages to inflation within a New Keynesian business cycle model with wage rigidities and labor market frictions. Our main focus is on the channel of real wage rigidities on inflation persistence for which we find the specification of the wage bargaining process to be of crucial importance. Under the standard efficient Nash bargaining, the feedback of.

Apr 12, 2017 Two key influences: productivity and real wages. The first is the real wage – the purchasing power of the worker’s pay packet, which brings into play prices of goods and services.
May 06, 2016 This shows that real wages show the purchasing power of the person. Real wages indirectly affect the money wages, since as real wages rise, they may force employee to demand a higher money wage. Money wages may or may not affect real wage, but higher money wages can increase the cost of living which could indirectly affect the real wage.
Feb 22, 2021 The purpose of nominal wage is simply to provide an individual with an expected dollar amount they will receive for their work within a given time frame from an employer. In contrast, the purpose of real wage is to help individuals determine how a dollar amount's value changes in response to changing inflation rates.
Sep 02, 2015 Next we multiply the real median hourly wage by the real compensation-to-wage ratio to convert the wages to compensation. Wage growth data For more information on methodology, see the documentation and methodology for Table 4.7 of The State of Working America (Mishel et al.

Wage Flexibility:

The importance of wage flexibility arises from the fact that, in most macroeconomic models, we find an inverse relationship between wages and employment. Unemployment is thus associated with wages in excess of full-employment level and the persistence of unemployment then depends on how quickly wages adjust in the face of unemployment.

It is often argued that if wages were very (if not completely) flexible, unemployment would be eliminated quickly and automatically by wage cuts, and that, consequently, any persistence of unemployment must be attributable to wage rigidity.

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No doubt wage inflexibility plays a crucial role in explaining unemployment in both classical and Keynesian models. But the mechanism through which it does so is quite different in the two cases. Classical unemployment occurs when the real wage exceeds the marginal product of labour at full employment. So, it is not profitable for firms to employ the whole labour force.

It can only be reduced by cuts in real wages, which makes it profitable for firms to employ some more workers at the margin. Keynesian unemployment is caused by a deficiency of aggregate demand. But aggregate demand is largely determined in nominal terms so that a cut in money wages, and, hence, in prices, tends to raise real aggregate demand.

Thus, it is the inflexibility, or downward rigidity, of money wages which is the crucial assumption in explaining why unemployment persists in the Keynesian system (even when the economy is in equilibrium, i.e., a situation of underemployment equilibrium in Keynesian terminology).

The effectiveness of money wage flexibility in reducing unemployment depends on the interaction of wage-setting and price-setting behaviour. As Keynes stressed in the General Theory (1936), if a change in money wages leads to an equi-proportionate change in prices, as the behaviour of competitive market might lead one to expect, it will leave the real wage unchanged.

Thus, in the Keynesian system, the wage bargaining (which is generally conducted in money terms) has no direct effect on the real wage. If the price level is fixed, a fall in money wages will reduce real wages but, because there is no fall in prices, there is no stimulus to aggregate demand, and, hence, a fall in money wages will not help remove Keynesian unemployment. We may now discuss in detail the relation between the price flexibility and full employment in the classical and Keynesian models against this backdrop.

Essentially a Static Analysis:

The static Keynesian model rules out the possibility of automatic full employment. There is no guarantee that the desired savings will automatically be equal to investment. This point is illustrated in Fig. 1. Here, desired real savings (S) and investment (I) are assumed to depend only on the level of real income (Y). There are three possible investment schedules—I₁, I₂, I₃. Here, Y₀ is the full employment level of income. If the investment desires of the businesses are represented by the curve I₁, desired savings at full employment exceed desired investment by EE’.

This will lead to unemployment, in which case the level of income will fall to Y₁ at which desired savings are equal to desired investment. Conversely, if I₃ is the investment schedule, a situation of overfull employment or demand-pull inflation will arise. Businesses desire to invest more at full-employment than is possible with the current level of savings.

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Only if the investment schedule happened to be I₂, the economy would reach full employment level, with desired investment equal to desired savings. Since, in Keynes’s model, investment decisions are independent of savings decisions, there is no reason to expect the investment schedule to coincide with I₂. Hence there is assurance that automatic full employment will result.

While defending the classicists, Don Patinkin argues that desired savings and investment depend on the rate of interest as well as the level of income; and that, granted flexibility, variations in the interest rate serve as an automatic mechanism for ensuring full employment.

The Classical Theme:

Patinkin’s defence of the classicists can be interpreted as- the savings and investment functions (representing what households and businesses desire to) are written as:

S = f (r, Y)

I = g (r, Y)

where r is the rate of interest.

In Fig. 2, we have drawn a whole family of curves relating savings and investment to the rate of interest—one pair for each level—and real income. In Fig. 2, these pairs of curves are drawn for full-employment income, Y₀, as also for lessthan full-employment income Y₁.

Since it is assumed that for a given rate of interest people will save and invest more at a higher level of income, the investment curve corresponding to Y = Y₀ lies above that corresponding to Y = Y₁. The same is true for the two saving curves. These are also consistent with the assumption that, at a certain level of real income, people desire to save more and invest less when the rate of interest increases. This is essentially a classical argument.

We now consider the pair of curves, which correspond to the full employment income Y₀. If in Fig. 2, the rate of interest were r₁, then households would be desirous of saving more at full employment than businesses would plan to invest. If the interest rate continued to fall, savings would fall and investment would increase. The process would continue until finally desired full employment savings and investment would be equated at the level S₀ = I₀.

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In a like manner, if, at full employment desired investment exceeds desired savings, a rise in the interest rate will prevent inflation. This is why variations in the rate of interest serve automatically to prevent any discrepancy between desired full-employment investment and savings, and, thus, to ensure full employment.

This point may also be illustrated in terms of Fig. 1. Let us assume, for analytical convenience, that desired investment depends on the rate of interest as well as the level of real income, while desired savings depend only on the latter. Then a fall in the rate of interest will raise the investment curve from, say, I₁ to I₂.

That is, at any level of income, businesses can be encouraged to invest more by a reduction in the rate of interest. In a like manner, a rise in the rate of interest will shift the investment curve downward from, say, I₃ to I₂. Thus, at full employment

Importance Of Money Wages And Real Wages