Answer to Question #119009 in Macroeconomics for Aynul

Question

One of the core Classical Economist believes was the flexibility of prices. Explain how Keynes showed otherwise from the perspective of the economy’s labor market with the aid of a diagram.

Answer 1

In the Classical Economist model there is a core assumption that prices and wages are flexible more so in the long-term. For instance, if there was a fall in aggregate demand, in the classical model this fall this would result in changes in the demand for labour and wages. That is there would be a fall in the labour demanded which would then ensure that full employment is maintained. This would cause the labour demanded to fall from W1 to We.

Keynesian argues that wages are often inflexible .This means that workers will resist the wage cuts through the trade unions that will represent the interest of the workers. For instance, if the demand for labour falls, trade unions would reject wage cuts. Keynesian brings it out very clear that labour markets will have a disequilibrium. Wages will therefore remain at W1. This is illustrated by the following graph.