Aggregate Take Away Together With The Labour Market

I’m surprised I exercise non encounter a diagram similar this to a greater extent than often:

The dark lines are familiar from whatsoever introductory macro textbook. There is a labour render curve. It is drawn such that a higher existent wage encourages to a greater extent than labour supply, but I volition visit what happens if it is vertical later. What I telephone phone the ‘unconstrained labour demand’ bend is what firms would direct to exercise if (a) labour gets less productive equally output increases (which is why the bend slopes downward), in addition to (b) firms tin sell whatever they like. This is the classical model, in addition to you lot volition observe this diagram inwards nearly every introductory textbook. With flexible payoff the grade of work is determined at the intersection of the 2 curves, in addition to nosotros could telephone phone it the ‘natural’ work level.

However (b) is a fiction. No (surviving) theatre produces what it wants to, irrespective of whether people desire to purchase its product. Aggregate need tin diverge from the grade of output implied past times the intersection of the 2 dark curves for all kinds of reasons: Says Law does non hold. For simplicity, suppose the aggregate need for goods inwards the economic scheme is independent of the existent wage, in addition to in that location is no share substitution. In that instance work is determined past times my carmine line - it is determined solely past times aggregate demand. This is pretty clear inwards the instance that I accept drawn, where nosotros accept deficient aggregate demand. Firms create what they tin sell: they would similar to sell more, but in that location is no betoken producing to a greater extent than if no i wants to purchase more.

It is less clear what happens if the carmine line shifts right until nosotros accept excess aggregate demand. If the publish of firms is fixed, why would they create to a greater extent than than they desire to - i.e. at a grade where they are losing coin on the extra products they are producing? In New Keynesian models where firms are monopolistic in addition to prices are gummy they volition create to a greater extent than if excess need is modest, because for given prices it is profitable to create to a greater extent than upward to to a greater extent than or less limit. But volition firms last prepared to pay higher (e.g. overtime) payoff to workers for long, or volition workers last prepared to move to a greater extent than for unchanged payoff for long? I volition come upward dorsum to this at the end.

If in that location is deficient demand, is in that location anything that makes the carmine line motion right to accomplish the natural work level? With deficient demand, prices may tend to fall, but that lone is unlikely to shift the carmine line to the right: few people beak nearly Pigou effects anymore, in addition to the full general job concern is that deflation is deflationary because the existent value of debt has increased. It is monetary policy that shifts the carmine line inwards the required direction, either because it responds to falling prices or because it wants to trim down the output gap. Ironically, Real Business Cycle models, which assume the carmine line is ever at the natural work level, solely brand feel inwards a footing where monetary policy is really efficient. However, monetary policy does unremarkably move over the medium term, which is why the classical or RBC model makes feel if nosotros are only doing medium/long term analysis.

What happens to the existent wage? In the most basic of New Keynesian models, the labour marketplace clears, which agency existent payoff autumn until the labour render bend intersects the carmine line. (Here a vertical render bend would last a problem.) If, inwards contrast, existent payoff were sticky, nosotros would larn involuntary unemployment - rationing inwards the labour market. Which is truthful matters a bang-up bargain to those unemployed, but it terms of modelling deviations from the natural charge per unit of measurement the difference is non that great. Real payoff accept no straight touching on on aggregate demand, in addition to then all that mightiness occur is that monetary policy could last influenced i way or the other. If it is not, what happens to existent payoff is irrelevant to the basic problem, which is deficient aggregate demand. This is i argue why New Keynesian economists may last happy to move amongst a model where the labour marketplace clears, but there may last other reasons.

The vertical carmine line assumes no share substitution. With share commutation it tin move downward sloping: falling existent payoff atomic number 82 firms to substitute labour for capital, which tin increment work fifty-fifty if output is unchanged because aggregate need is unchanged. As I speculate inwards this post, based on the work of Pessoa in addition to Van Reenen, something similar this could aid explicate the electrical flow UK productivity puzzle. If this speculation is correct, at to a greater extent than or less betoken equally aggregate need in addition to investment expands existent payoff volition rise, in addition to labour productivity volition increment equally share commutation is reversed.

I was prompted to write this post past times this from Noah Smith, which inwards plough comments on a Nick Rowe.) They beak nearly models of labour marketplace matching, which I accept non mentioned, but similar considerations apply amongst matching models taking the house of the classical model (although in that location are fundamental differences betwixt the two). This gives me to a greater extent than or less other gamble to plug an AER paper past times Pascal Michaillat, which addresses the possible asymmetry that may occur when nosotros accept excess demand. Michaillat’s model is a matching model when aggregate need is strong, but a rationing model (with Keynesian involuntary unemployment) when aggregate need is low. This is one, rather interesting, response to the enquiry I asked higher upward nearly possible asymmetry. Putting matching together amongst Keynesian rationing is complicated, but if Michaillat’s newspaper is ignored only for this reason, that says something rather lamentable nearly electrical flow macro methodology.