Blogging the General Theory: Chapter 2, post 2.

So what does Keynes object to in classical theory?  He starts with the classical theory of the labour market.  This, he says, is based on two fundamental postulates.  The first is that the wage is equal to the marginal product of labour.  He defines this as the value which would be lost if employment were to be reduced by one unit, and from his terminology he seems to be referring to the nominal wage.  On the demand for labour curve front, JMK is pretty classical – we seem here to be looking at the thing we would call the value of the marginal product, meaning, in a competitive economy (which JMK for the most part assumes) price times the marginal physical product curve of labour.  No problems here – it’s the second postulate which JMK objects to.

That postulate is that “the utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment”.  Keynes then goes on to say that this means that the real wage is just sufficient to “induce the volume of labour actually employed to be forthcoming”.  The real wage (notice the “real” part) just compensates for the disutility of a certain volume of labour.  Or as we might put it, the real wage is the supply price of that quantity of labour. 

These two postulates, JMK says, give us the demand and supply curves of labour, and in classical theory the actual level of employment is at their intersection, labour market equilibrium, where “the utility of the marginal product balances the disutility of the marginal employment”.

We’ll get to JMK’s critique of this in a bit – remember that what he’s doing at this stage is setting out what he sees as the classical theory.   As part of that, he notes that classical theory does recognize two kinds of unemployment.  One is frictional unemployment, which just represents impediments to the bringing together of unemployed workers and unfilled jobs.  We use the same term today – the fact that there are always some people moving between jobs is the reason we tend to define full employment as meaning somewhere around three or four percent unemployment (the Australians, in an earlier period of mineral boom, once defined it as about two percent unemployment, and the Swiss are said, once upon a time, to have regarded it as disastrous when unemployment rose above one per cent).  Keynes says the same thing about frictional unemployment as we do -  it can be reduced by making labour market institutions work more efficiently. 

Classical theory, as JMK sees it, also admits of voluntary unemployment: 

“unemployment due to the refusal or inability of a unit of labour, as a result of legislation or social practices or of combination for collective bargaining or of slow response to change or of mere human obstinacy, to accept a reward corresponding to the value of the product attributable to its marginal productivity”

Sounds like unemployment due to wage stickiness, doesn’t it?  Remember that we’re still talking about JMK’s interpretation of the classical model, not his own model, but you have to be cautious about saying that Keynesian unemployment is due to downward stickiness of wages.  At the very least because that’s a disequilibrium explanation of unemployment, not a model of an unemployment equilibrium.