According to John Maynard Keynes, the classical economists of his day taught that the “utility of the wage when a given volume of labour is employed is equal to the marginal disutility of that amount of employment” (The General Theory of Employment, Interest, and Money, 5). If the classical school economists taught the above, then they must have been assuming that there was no surplus of labor, i. e. no unemployment. Think about it. If the wage is too low, then the wage is equal to the marginal cost of the “last” worker hired (Thanks to Axel Leijonhufvud for that way of phrasing it. He, of course, meant the worker who just barely accepts the offer). Same goes for when the wage is set where supply meets demand. However, when the wage is too high, the wage is above the marginal cost of everyone employed. The classical school, therefore, must have been assuming that there is no unemployment.
Keynes tried to refute the classical school economists by referring to “the actual behavior of labour” (General Theory, 12). He wrote, “A fall in real wages due to a rise in prices, with money-wages unaltered, does not, as a rule, cause the supply of available labour on offer at the current wage to fall below the amount actually employed prior to the rise of prices” (General Theory, 12 & 13). Classical economists seem to be assuming that the marginal worker, the one who just barely accepts the offer, would refuse to work for a “penny” less in real terms, as opposed to nominal terms. Therefore, the real wage drops, and the quantity supplied falls slightly. There is now a shortage of labor. The important question is why the marginal worker would withdraw from the labor market. It could be that his marginal cost of working that hour exceeded his marginal benefit; so he abstained from working. Maybe, he keeps working because he is under a “money illusion” (Recall that his nominal wage is unaltered). If he is not under any illusion, then it’s reasonable to think that he, the “last” or marginal worker, would not work the same amount of hours as before.
What’s the problem then with the classical thinking other than the appeal to “actual behavior”? Keynes relied on not just empirical evidence but a logical argument. He wrote that to suppose that the quantity of labor supplied would fall “is to suppose that all those who are now unemployed though willing to work at the current wage will withdraw the offer of their labour in the event of even a small rise in the cost of living” (General Theory, 13). I’m afraid I can’t follow his argument. Is he saying that supposing one worker would refuse to work is the same as supposing a group of people would refuse to work? (Recall that he wrote, “fall below,” which could mean to fall by an infinitesimal amount.) If a group is now refusing to work, then it could only be the case that there is a tacit or explicit agreement among them to not work for less than a specific wage. Here is why Keynes wrote utility instead of cost. As he explained, disutility “must be here understood to cover every kind of reason which might lead a man, or body of men, to withhold their labour rather than accept a wage which had to them a utility below a certain minimum” (General Theory, 6, emphasis added). Here, he distinguishes between individual decisions and decisions made simultaneously by a group. I struggle to see how an observation that could apply to one individual has implications for a “body of men.” Furthermore, the situation where the one man or maybe a handful of men don’t quit because they are (temporarily?) under a money illusion could be a situation where labor supply equals labor demand. It’s dissimilar in that respect to a situation where there is unemployment. If all Keynes was saying was that workers are under a money illusion temporarily, then I don’t believe classical economists would disagree. I don’t see how such an observation vitiates “orthodox” economics.
Let’s, for the sake of argument, suppose that one worker would refuse to work for less than a certain amount per hour. No difficulties arise in that situation for the amateur economist. He can draw his upward-sloping supply curve and say, “marginal cost” to himself. Now, let’s suppose that all of the unemployed would refuse to work for less than a certain wage. If I’m not mistaken, the supply curve for labor (or as Keynes put it, the supply schedule) would have to be horizontal at that particular minimum wage. At that wage, the one that is acceptable to the unemployed, the quantity supplied would be equal to the unemployed plus all those currently employed. Below that wage, what would the supply "curve" look like? Would everyone just refuse to work? If so, then the supply "curve" would be vertical, meaning zero people would work until the wage reached a certain minimum. Maybe, the supply curve would be upward-sloping after it reaches a wage that is truly minimum. Let’s call that wage an “insult” wage. I suppose that everyone has his “insult wage,” but admitting as much is not to admit that all of the unemployed have an “insult wage.” Generally speaking, one person with an “insult wage” (in economics jargon, “reservation wage”) doesn’t necessarily imply an entire group with one. If the currently employed falls because of a drop in the real wage, then we’ll have a labor shortage. In that situation, there need not be any tacit agreement or any customary attitude that would cause quantity of labor supplied to fall. Keynes may have been correct in his conclusion, but, if so, he didn’t succeed because of his purely logical argument unless the classical economists were assuming a kinked supply curve.
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