Theoretical explanations of unemployment: classical versus Keynesian approaches

Unemployment in the Labour Market Is Primarily Voluntary

talk about Keynesian theory, classical theory, new classical theory, new Keynesian theory,

neo-classical theory also mention the game theory, Marxian theory, natural rate of unemployment, and the rational expectations role. Please use graphs as well to explain

Unemployment is a particularly high topic in the news at the moment with the recession seemingly refusing to come to a stop and the number of people losing their jobs growing rather than declining. As with all issues, there is a remarkable amount of debate regarding the issues that stimulate this crescendo of unemployment. Classical economics and neoclassical economics both argue that classic market mechanisms such as that of Adam Smith are reliable means of economic health and government intervention / interference stimulates unemployment. They oppose theories that argue for interventions imposed on the labor market from the outside, such as unionization, minimum wage laws, taxes, and other regulations which, they claim, hinder the natural flow of the labor system. Unemployment, therefore, they say is largely the fault of the worker. Anyone can find jobs would he/she so wish. The fact that he is unemployed points to insufficient motivation.

Other theories, on the other hand, such as those of Keynesian economics, Marxism, game theory and the neoKeynesian theory are at best ambivalent to, if not anti-assertions of classical economics and call for government intention and/or inference from the masses. Keynesian economics sees unemployment as occurring in cyclical spates and calls for government intervention when unemployment is high in order to give a boost to the system. Helpful regulations can include programs such as financial stimuli, publicly funded job creation, and expansionist monetary policies. At the extreme end of the spectrum, Marxists see unemployment as a result of the deliberate oppression of the bourgeoisie or wealthy hiring class that cause competition and pit workers against one another in a constant struggle for wages and jobs. The resultant low wages paly into the employers' hands. The Marxist solution is a communist or socialist regime where capitalism is abolished and property is shared with wages allocated according to a set amount. The underlying point of all these theories is that unemployment is a construct of the social system -- either deliberately maneuvered (as in the case of Marxism) or incidental (as in the case of Keynesian economics).

Other systems that call for government intervention and see unemployment as being involuntary include the game theory, natural rate of unemployment, and the rational expectations role. This essay touches upon each of these models in turn.

Part 1. Pro-Capitalist Theories

Classical Economics

This theory believes that the economy is self-regulating in that it can always return to its former position of achieving the nearly level of real GDP. Whenever the country droops in its GDP production, self-adjustment mechanism exist within the market itself that will act to restore the country to its original level. This thesis stands on two principles: (1) Says' Law and (2) the belief that prices, wages, and interest rates are flexible.

Say's Law posits that the economy that produces a certain level of GDP also generates the same level of income needed to produce that level of GDP hence there is always a need for workers to generate the expected level of GDP and always a potential for employment that will balance the country's GDP. Flexibility of the wage rate (representative of the real GDP) keeps the labor market constantly in equilibrium. At times there is a greater demand for workers than at others, and less demand signals drop in wages. Hence according to classical economics, 'voluntary unemployment' is the state of affairs that occurs due to the fact that workers refuse to accept lower wages which are the necessity and mark of the time. If they would only accept these lower wages (at least until the economy naturally balances itself), they would be employed.

Graphical illustration of the classical theory as it relates to a decrease in aggregate demand. Figure 1 considers a decrease in aggregate demand from AD1 to AD2.

The economy moves down the SAS1 curve causing the price level to fall from P1 to P2 and real GDP to fall from Y1 to Y2. This causes drop in demand for workers, causing lower wages, resulting in voluntary unemployment. (The Classical Theory. Cliff's Notes.)

Neo-Classical Theory

Neo-classical economics rests on 3 assumptions:

1. People decide rationally based on their knowledge of different outcomes

2. People maximize utility (that which is pragmatic to them) and firms maximize profit

3. People act with full knowledge of each of the alternatives (Weintraub, 2007).)

Neoclassical utilizes Free's Market Theory and the Quantity Theory of Money to support its Employment theories.

Free's market theory, for instance, says that if employment is left to itself without government interference, any situation of unemployment would naturally right itself. To wit: wages become too high resulting in unemployment. Workers raise wages as a result, so the condition of unemployment naturally straightens itself. This is indicated in the following diagram where wage rates fall and unemployment increases from Q1 to Q2:

(Source: Biz/Ed. http://www.bized.co.uk/virtual/economy/library/theory/classical2.htm)

Both classical and neo-classical economics work on the Natural Rate of Unemployment and on the 'Rational Expectations Theory'

The Natural Rate of Unemployment

This is also defriend as the equilibrium rate of unemployment where the aggregate supply of labor corresponds to the aggregate demand for labor. There is equilibrium. People, however, have to be content in working for the particular wage level of the moment. Those who refuse to do so are 'voluntarily unemployed.

Rational Expectations Theory

This is the economic idea that people decide based on their rational outlook, available information and past experiences. Economic decisions of the present, therefore, (whether of company or individuals or of country) determine future economic conditions and decisions. (Investopedia. 'Rational Expectations Theory')

Part 2. Intervention in Economics

3. Marxism

Marxists see unemployment as a result of the deliberate oppression of the bourgeoisie or wealthy hiring class that cause competition and pit workers against one another in a constant struggle for wages and jobs. The resultant low wages paly into the employers' hands. The Marxist solution is a communist or socialist regime where capitalism is abolished and property is shared with wages allocated according to a set amount.

According to the Marxist, therefore, there is no such thing as voluntary unemployment rather t it is a deliberate diabolical maneuvering of a greedy society that attempts to get the most skilled and excessive labor at the cheapest wage.

4. Game theory

According to game theory, industries and traders share all the rules of games. These include:

1. Rules, which govern conduct of the players

2. Pay-offs, such as win, lose or draw

3. Strategies, which influence the decision making process.

Firms have to make a number of decisions such as on price and output, on products, on marketing, on possible pay-offs, and on gaining more profit for their firms. In this way, employment can be seen as both voluntary and involuntary. It is involuntary in that the person is laid off as a result of a stratagem / game of his firm that decides that the spate of unemployment's will be more lucrative to his industry. Ion the other hand, the individual may decide to play a game of his own and deliberately choose unemployment as part of for instance, desiring a simpler life, seeking higher wages, a more stimulating job etc. (Game theory. Economics Online.)

Sources

The Classical Theory. Cliff's Notes

< http://www.cliffsnotes.com/study_guide/The-Classical-Theory.topicArticleId-9789,articleId-9741.html>

Keynesian Economics The Concise Encyclopedia of Economics.

Game theory. Economics Online.

Gordon, R 1990, 'What is New-Keynesian Economics?', Journal of Economic Literature

Weintraub. RE. 2007. 'Neoclassical Economics'. The Concise Encyclopedia Of Economics.

'Rational Expectations Theory' Investopedia.