Blogging the General Theory: Chapter 2, post 3.

Remember that bit from a couple of posts ago about wage-goods and non-wage-goods?  This is where it shows up in the GT: as one of a list of four ways employment can be increased in the classical model, as JMK sees it.  

The first of the four is a improvement in labour market institutions, which reduces frictional unemployment.  No problems there.

The second is a reduction in the disutility of labour and a downward (or rightward) shift of the labour supply curve giving a drop in the supply price of labour.  (Remember, this is JMK on the classical model).

The third is an increase in the marginal physical productivity of labour in the wage-goods sector, and here we finally get a definition (drawn from Pigou) of wage-goods: “goods upon the price of which the utility of the money wage depends”.  Basically, it refers to the consumer goods which labour buys.  Non-wage-goods are defined as stuff which labour doesn’t buy.  Keynes was writing at the end of a period in which the functional and social distributions of income were the same thing – labour income referred both to the marginal productivity of labour and to the income of a particular social class.  The idea of labour having capital income (through shares owned by pensions funds, for example) doesn’t get play here.  Part of the difficulty we have in reading the writings of JMK’s disciples in the 1950s relates to their insistence on maintaining the functional/social parallel.  

And the fourth is that business about an increase in the price of non-wage goods.  For simplicity, think of wage goods as being consumption goods and non-wage-goods as being capital goods.  Now, suppose there’s an increase in demand for capital goods.  That will raise the price of capital goods.  Next, think about the labour market diagram, with nominal (not real) wages on the vertical axis.  The increase in the price of capital goods raises the value of the marginal product of labour in the capital goods sector and shifts the overall labour demand curve out.  Because the price which has increased is that of capital goods and because the price which matters when labour is comparing the disutility of work to the real wage which work will bring it is the price of consumer goods, the increased price of capital goods doesn’t reduce the real wage of labour, there is no shift of the labour supply curve but there is a movement along it as the increased demand for labour in the capital goods sector drives up the nominal (and, as far as labour is concerned, real) wage.  So we wind up at a new full-employment equilibrium with a higher level of employment than we had at the old labour market full-employment equilibrium.

Now suppose it had been the demand for, and price of, consumer goods which rose.  The labour demand curve would still shift out to the right but now (remembering that we’re drawing this with the nominal wage on the vertical axis) the real wage to labour falls as the price of consumer goods rises.  So the nominal wage associated with any level of labour being supplied has to rise by the same proportion as the price level rises in order to hold the real wage associated with that quantity of labour unchanged – the nominal supply price of labour has to rise so the labour supply curve as we drew it shifts up (or back, if you prefer).  Upshot, no increase in employment.  

Remember all that; we’ll need it again later in the chapter.