Home > Uncategorized > P7: GT02 Keynesian Unemployment

P7: GT02 Keynesian Unemployment

from Asad Zaman

unemploymentThis 7th post in a series about re-reading Keynes, starts the discussion of Chapter 2 of General Theory, which deals with the Classical (and neoclassical) Postulates characterizing the Labor market. The astonishing fact is that Keynes central arguments regarding how the labor market can fail to be at equilibrium, despite flexible wages, were never understood. As a consequence, the theory of the labor market is taught today exactly as it was prior to Keynes, and completely disregards Keynesian objections, and the Keynesian alternative. This post makes a start on Chapter 2, and the analysis will be continued in later posts.

In this chapter, Keynes formulates and rebuts the (neo)-classical theory of the labor market and presents an alternative theory of employment. This chapter was apparently never understood by economists, who mis-interpreted it as stating that unemployment arises due to price rigidities. In fact, Keynes held this position earlier, but renounces it explicitly in this chapter. His theory of employment states that the real wage is an “emergent” phenomenon. That is micro level decisions and actions of laborers and firms are based on nominal wages, but the complex economic system itself determines the general level of prices which is not in control of individual agents. So the real wage is out of reach of individual actors, and even though all parties may try to reduce real wages, they may fail to do so, because prices may respond in un-anticipated ways.

Keynes starts out be stating the classical postulates for the labor market, which continue to be the basis of modern labor economics.  read more

  1. Paul Davidson
    December 24, 2016 at 6:09 pm

    you make it ore difficult than is needed to understand Keynes. First you confuse market clearing with market equilibrium. Market equilibrium merely means there is no supply or demand factor that will change the existing position in the market –even if the supply of labor exceeds the demand for labor at the going market real wage rate.

    Second the three classical postulates that Keynes rejected are (1) the neutral money postulate — where all market demand curves are specified in a price ratio– so that changes in the money supply that may affect the price level has no effect on all market demand functions.

    (2) the gross substitution postulate, where everything is a substitute for every thing else. This is explicitly rejected in Chapter 17 entitled “The Essential Properties of interest and Money” where on page231 Keynes explicitly indicates hat all liquid assets have an elasticity of substitution with producible durable capital goods “equal, or near equal, to zero” Thus even if prices of liquid assets change relative to price of producible durables, savers will not substitute producibles for nonproducible liquid assets [ the first “essential property] of money and all liquid assets] as a place to store one’s savings.. Thus any penny of income saved is a penny that cannot be earned by any producer of goods and services.

    (3) the future is uncertain and cannot be predicted based o past facts [ the nonergodic axiom]. Since all market transactions are organized by legal money contracts– then one must store one’s savings in money or any liquid asset readily convertible into money in order to meet any unanticipated future contractual obligation!!

    • December 27, 2016 at 3:51 pm

      Excellent points.

      With regard to (2) this gross substitution through price equivalency postulate is the ghost in the machine and the mechanics of microeconomics of ‘consumers and firms’ generally, with it playing a particularly important role in the pseudo-mechanics of consumer decision-making because these mechanics insist that any and all ‘consumption’ is ‘satisfactory’, which divorces the realization of needs and wants from the objective outcomes of realizing or failing to realize a given level to consumers. The latter is what satisfaction or dissatisfaction with what one can afford depends upon (as well as consumer preferences about how to realize one’s needs and wants).

  2. Norman L. Roth
    December 24, 2016 at 7:43 pm

    Dec. 24, 2016

    Alas, both of you, in good faith and with the best intentions are caught in the same labyrinth of Ptolemaic epi-cyclic thinking that hobbled astronomy and cosmology until Copernicus revived the almost forgotten simple uncluttered Helio Centric explanation of Aristarchus of Alexandria (Correct me on this one if needed)

    This is what TELOS and TECHNOS is all about. There is no need for convoluted .explanations and bringing in superfluous variables in a paradigm based on interaction, where the events are the time, path dependence is obvious, human action and choice matters ,and the roots of uncertainty are part of the territory.. Employment levels are then explained as the result of one of the key emergences of a complex, quasi organic system of emergent properties;…the Natural Participation rate (Read Chapter 4 )….And the summary at the back jacket of the book.

    Have a politically incorrect merry Christmas a nd a Happy New year guys.

    GOOGLE,(1) Norman L. Roth: And ¨(2), Norman L. Roth, Technological Time, (3) Norman L. Roth, Origins of Markets (4) Norman L. Roth, Current Conception of the Standard of Life

  3. December 25, 2016 at 6:25 am

    Paul Davidson — thanks for your remarks. I am hoping for your help in understanding the complexities of Keynes. My project of re-reading is motivated by the conviction that the wrong side won the Methodenstreit — history was removed from the picture, and a “scientific” methodology, with pretensions of establishing economics as a set of universal laws, was accepted. This was a big mistake. All theories are born out of attempts to understand contemporary or past historical experience, and abstract from these experiences. Thus, to understand Keynes, we must understand the historical environment, and the economic experiences of Keynes. I am at a handicap in undertaking this exercise, because I know very little about Keynesian theory and also very little about the historical background in which these theories were born. I am hoping to learn from experts (you on theory, others on history, yet others on complexity).
    In terms of the three points you make, I am familiar with the second two, and hope to get to them when we come to the relevant portions in Keynes GT. I could not understand the first point from your brief description — what is the distinction between market equilibrium & market clearing?

  4. Norman L. Roth
    December 25, 2016 at 2:44 pm

    M. Zaman.

    The best source for Keynes ideas about relevant historical context is clearest in ECONOMIC CONSEQUENCES of the PEACE.1919,1920.It is a truly great & enduring book ,including its prescient views about how the presence of economic (not legal, judicial and moral) inequalities do not necessarily retard economic progress or lead to a lack of the necessary capital (however classified) to activate it….with clear historic examples to prove it. I think M. Paul Davidson would be the best teaching authority on that topic. Incidentally, Keynes got his practical start as a working economist for the Indian Civil Service. He had some very interesting things to say on the Indian economy of that time as well. I would add that the concept of (time) path independence, a foundation of TELOS & TECHNOS, is the best vehicle for respecting and including the lessons of history. Truly the EVENTS are the TIME.

    Thank you for your patience and consideration on this subject.

    Norman L. Roth.

  5. Paul Davidson
    December 25, 2016 at 6:03 pm


    The term market equilibrium merely means there are no factors changing the existing market outcome. Thus when Keynes writes about [involuntary] unemployment equilibrium, he means that given the wage rate, the demand for labor is less than the supply of labor and the market is in equilibrium while there is not market clearing of the labor market and there are still unemployed laborers willing to work t the going market wage.

    In terms of the marginal productivity curve [downward sloping] which is often mislabeled the demand for labor function relative to the supply of labor function- where at the going real wage the supply of labor exceeds the marginal productivity value –

    -HYPOTHETICALLY please note that the marginal productivity function presumes a given level of aggregate market demand for all market producible goods and services. Thus if one assumes a reduction in the real wage rate in the market, this reduces aggregate labor income which in turn reduces total market aggregate demand– thus shifting the marginal productivity curves inwards and therefore not reducing or eliminating the excess supply of labor!! ,

  6. December 26, 2016 at 9:25 am

    Although Keynes did say:

    ” A reduction in money-wages is quite capable in certain circumstances of affording a stimulus to output, as the classical theory supposes.”

    • December 27, 2016 at 4:10 pm

      But, Keynes goes on to say:

      “The argument simply is that a reduction in money-wages will cet. par. stimulate demand by diminishing the price of the finished product, and will therefore increase output and employment up to the point where the reduction which labour has agreed to accept in its money-wages is just offset by the diminishing marginal efficiency of labour as output (from a given equipment) is increased.

      In its crudest form, this is tantamount to assuming that the reduction in money-wages will leave demand unaffected. There may be some economists who would maintain that there is no reason why demand should be affected, arguing that aggregate demand depends on the quantity of money multiplied by the income-velocity of money and that there is no obvious reason why a reduction in money-wages would reduce either the quantity of money or its income-velocity. Or they may even argue that profits will necessarily go up because wages have gone down. But it would, I think, be more usual to agree that the reduction in money-wages may have some effect on aggregate demand through its reducing the purchasing power of some of the workers, but that the real demand of other factors, whose money incomes have not been reduced, will be stimulated by the fall in prices, and that the aggregate demand of the workers themselves will be very likely increased as a result of the increased volume of employment, unless the elasticity of demand for labour in response to changes in money-wages is less than unity. Thus in the new equilibrium there will be more employment than there would have been otherwise except, perhaps, in some unusual limiting case which has no reality in practice.

      NOTE: Keynes seems here to be clearly rejecting the homogeniety of labor assumption that implies the gross substitutability of labor at a given real (or nominal) wage rate. Though he does not do this explicitly, his sequestering of workers into those who have lost and those who have not clearly implies non-homogeniety.

  7. December 27, 2016 at 3:37 pm

    Another argument for why nominal wages matter is that for conversion to real wage, laborers use a price index for the consumer goods they purchase, while firms use a price index for their inputs and outputs, and these two are different.


    THAT is a very important point! Put differently, if the neoclassical ‘consumer’ is, indeed, a ‘producer-who-consumes’ to obtain/provide himself or herself (and family) with objective benefits from consumption, then the latter looks upon ‘consumer goods’ in terms of what are ‘outputs/outcomes’ within his or her life, meaning that every ‘consumer’ has objective considerations that must, at the least, be realized if there is going to be any ‘consumer satisfaction’ with what one is able to consume. The realization of, or the failure to realize, objective benefits from what one can afford to ‘consume’ determines whether or not a consumer can be said to be subjectively satisfied or dissatisfied within and across a complex stream of essential needs and less essential wants.

    Another aspect of this is that what a worker sells is an production input to firms but also that the wages/salaries/incomes received are themselves inputs into that consumer’s production of objective (and subjective) benefits for himself or herself. Because the consumer is a body, has a body, and acts out of that body, we can say that some of the objective benefits the consumer seeks as ‘ouputs’ have to do with keeping body and soul together, so to speak, healthily alive, whereas others have to do with levels of satisfaction that are functionally related to other socio-cultural-technical need and want realization.

    Put even differently, the ‘firm’ is a ‘producer-who-consumes’ also whose ‘consumption’ is ‘inputs’ to produce objective ‘outputs’ which themselves must be sold to ‘realize’ objective ‘profits (or losses, depending on what they can be sold for).

    Which is to say that the difficulty with current micro is an artificial distinction between ‘consumers’ and ‘firms’ based on what is being produced and for what objective benefits both monetary and non-monetary.

    Thank you, Assad, for a most interesting post.

  8. Norman L. Roth
    December 27, 2016 at 5:09 pm

    Dec. 27,2016

    Please reference M. Paul Davidson’s posting of December 24, {2} Re: Keynes’ rejection of the Gross substitution postulate. “where everything is a substitute for every- thing else”

    Psss-ssst ! All you closet rejectionists of Keynes on this subject. .Especially those who still insist that you are true-blue heirs to the neo-“classical” Keynesian “synthesis” .Please reference Page 102 of TELOS & TECHNOS, Appendix 16 of 197 page edition {not the 256 page edition}:

    In a NEOCLASSICAL ANALYSIS of the ECONOMICS of NATURAL RESOURCES, Joseph Stiglitz proclaimed {1979}: “Natural Resources are no different from {i.e. are infinitely substitutable for} other factors of production”
    Not to be out-done, the equally neoclassical ‘synthesizer” Robert Solow pursued the gross substitutability dogma to its bitter end: “The world, can in effect, get along without natural resources”….”The belief in gross substitutability carries inside it entrails, the grossest of inconsistencies….”

    How can any body take them seriously ?

    Please GOOGLE: Norman L. Roth, Economics

  9. Norman L. Roth
    December 27, 2016 at 6:09 pm

    Dec. 27, 2016

    There is a typo graphical error in my post of Dec. 25, 4th line from the bottom, 2::44 p.m…Last full sentence: `Path independence` should read `Path dependency`.

    Thank you, Norman L. Roth, A great New Year to All of you ! Regardless of any differences
    in perspective.

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