Blogging the General Theory: Chapter 2, post 4.

 All of that is JMK’s take on the classical theory of the labour market.  Next (we’re up to part II of Ch. 2) we have his comments on it.  And his first comment is that, in the real world of 1936, there were more people willing to work at going wages than there were jobs for them.  The classical school, he argues, explain this by saying that the problem is that real wages are too high, and labour won’t let them fall to the equilibrium level, making the unemployment voluntary, not involuntary.  JMK obviously isn’t likely to agree with this, and he makes two observations.

The first is that while, as he sees it, a drop in real wages due to a drop in nominal wages would lead to a reduction in the quantity of labour supplied (“through strikes and otherwise.......a withdrawal from the labour market of labour which is now employed”), an equal drop in real wages due to a rise in the price of wage-goods wouldn’t.  Keynes says that this point is not theoretically fundamental, but he certainly gives it a lot of play.  He’s arguing that, within limits, labour supply depends on the nominal wage and not on the real wage – so long as the change in the price level is relatively small, labour supply responds to changes in the real wage which are due to changes in the nominal wage but not to ones which are due to changes in the consumer price level.  He qualifies that, a bit later on, when he says that if the change in prices is large enough, workers will respond to it, but much of the argument in the early stages of GT is about the nature of the labour supply curve.  Which raises an obvious question – while JMK said that this point was not fundamental to his model and his argument about the nature of unemployment equilibrium, can we take it to mean that the more sensitive workers are to the cost of living in determining the supply price of their labour, the closer we are to being in a classical world?

There is still, however, the labour supply issue which JMK does regard as fundamental in differentiating his theoretical model from the classical model.  The classical model acknowledges that employers and workers bargain over the nominal wage, but, according to JMK, assumes that this is the same as bargaining over the real wage.  That means that the real wage in the overall labour market can be brought down by cutting the nominal wage, so if there is (non-frictional) unemployment in a classical world it must be because labour is refusing to bargain the nominal wage down.  Keynes holds that bargains over the nominal wage do not determine the real wage.  The exposition’s a bit frustrating here, since we’re going to have to wait for Chapter 19 for a Keynesian theory of wages - the theory of wages depends on other bits of the Keynesian model to be developed (and we’re still in Chapter 2, remember).  The upshot, though, is that just because unemployment is associated with labour receiving too high a real wage doesn’t mean that it’s caused by labour demanding too high a real wage.  More on that in a bit.