ECON 102 AMU Week 4 Classical

Classical economists belief that prices and quantities adjust to the changes in the forces of supply and demand and that the economy produces its potential output in the long run.  On the contrary, Keynesian economists believe because of price and wage rigidities the economy’s equilibrium output in the long run may be less than its potential output.  What is price-wage rigidity?  Do you agree with Keynes assessment that wage-price rigidity requires government’s involvement in the markets?  Why?  Why not?  

The sticky wage theory hypothesizes that employee pay tends to respond slowly to changes in company performance or to the economy (Hayes, 2020). According to this theory, when unemployment rises, wages remain the same or rise slowly for those that are employed versus declining as a whole. This is largely due to workers willingness to fight against reduction in pay, leading companies to seek alternative ways to reduce costs (i.e., layoffs).

According to Investopedia (2020), Keynes advocated a countercyclical fiscal policy in which, during periods of economic woe, the government should undertake deficit spending to make up for the decline in investment and boost consumer spending in order to stabilize aggregate demand.

Honestly, I do have conflicting thoughts in regard to Keynes’ assessment on wage-price rigidity requiring the government’s involvement. On one hand, I do believe that the government’s involvement would help the economy during a recession. I believe consumers would be willing to spend more of their income and trust that this would be beneficial to the economy. On the other hand, I also believe it would not work entirely. If the government were to step in, what stops them from raising taxes? What stops them from raising the equilibrium price to certain products once the economy gets healthy again?

Reference:

Hayes, A. (2020, November 30). What is the sticky wage theory? Investopedia. Retrieved September 30, 2021, from https://www.investopedia.com/terms/s/sticky-wage-theory.asp.

Investopedia. (2020, April 30). Keynesian economics definition. Investopedia. Retrieved September 30, 2021, from https://www.investopedia.com/terms/k/keynesianeconomics.asp.

Looking at price-wage rigidity is a system where price and wage did not level up at the equilibrium. In another words, wage-price rigidity is where the price and wage do not change to corresponds with the economic shift which resulted from shift in demand and supply curve. A case in point, where price rigidity move downward which leads to an excess in supply and the opposite lead to an increased in demand. Workers would not accept low wages, because low wages would not allowed them to live a comfortable life. This issues can be complicated by trade unions who backed up workers claims for fair wages. Keynes believed that wage would not change sufficiently in the short run to keep the economy at full employment. If wages are very low it will create unemployment. People will leave the labor market at alarming rate. Large companies confronted with increased wages and prices will rather cut production by laying off workers than increased wages. Government intervention in increased spending or lower the nations interest rate to lessen the gap at the equilibrium level is very important steps I will appreciate a lot. Government can also give incentives to individuals, and businesses investing in solar energy, business that hire military veterans and finally give soft loans to military veterans who want to set up their private businesses will go a long way to reduce stress on the nations’ economy.

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