Unemployment

Economists reserve the concept of unemployment for people who are involuntarily unemployed. That is to say, people are unemployed if they are actively seeking jobs but unable to find them, as opposed to people who have voluntarily opted out of the labor market to pursue activities like raising children, going to school, or traveling.

Some economists follow A. C. Pigou and his 1933 argument that unemployment does not exist. Their argument rests on the following two premises: (1) There is a real wage low enough to make it profitable for employers to hire every person actively seeking a job, and (2) people are in a position to offer to work at that real wage.

If these two premises are valid, then unemployment does not exist. For everyone could have a job if only they were willing to work at a real wage low enough to make it profitable for employers to hire them. Instead, people who appear to be unemployed voluntarily opt out of the labor market by deciding that the utility they derive from activities like raising children is greater than the utility they would derive from the consumption of the goods and services that could be purchased with such a low real wage.

In 1936, J. M. Keynes and his followers undermined Pigou's argument against the existence of unemployment on both theoretical and empirical grounds. The theoretical reason for rejecting Pigou's argument is that its second premise is invalid. Rather than being in a position to offer to work at the real wage low enough to make it profitable for employers to hire them, people are only in a position to offer to work at a lower money wage. As equation 1 shows, the relationship between the money wage (WJ and the real wage (Wr) is mediated by the price level (P):

For the second premise of the argument against the existence of unemployment to be valid, it must be the case that people who offer to work at a lower money wage (WJ are also invariably offering to work at a lower real wage (Wr). But equation 1 shows that a lower money wage (WJ only results in a lower real wage (Wr) if the price level (P) does not fall proportionately with the fall in the money wage (WJ.

The second premise of Pigou's argument is invalid, because once the macroeconomic effects of a lower money wage (WJ are taken into account, it is most likely that the price level (P) does fall proportionately with the fall in the money wage (WJ, so that the real wage (Wr) is not affected. The money wage (WJ is the major determinate of aggregate demand. By offering to work for a lower money wage (WJ, people [Page 975]reduce aggregate demand. As a result, inventories pile up, causing firms to lower prices (P), so that the price level (P) falls as part of the effort of firms to get rid of unplanned inventory accumulations. In short, the price level (P) tends to fall in tandem with a falling money wage (Wm), with the result that it is not likely that the real wage (Wr) will be affected.

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