The economy can be in equilibrium at a high level of unemployment.
People can choose more goods and less money, or more money and less goods. If they choose the in a sufficiently dramatic and surprising way, then you can end up with a general glut.
Of course both these arguments predate Keynes and Keynesian economics but nevertheless.
Microeconomics has its own ways of explaining persistent unemployment beyond the “natural rate” without invoking irrationality. These explanations have to do with a lack of information. They aren’t particularly new, either. Armen Alchian pioneered these models half a century ago.
Here’s an example of how things could go.
Aggregate demand drops, and so the employer, whose demand has also gone down, tries to lower the wages of his employees, who do not know that aggregate demand has dropped. They only see that their employer’s demand has dropped. They can rationally decide that it is worth quitting their job rather than taking they pay cut and looking for a job that will pay them what they think they are worth elsewhere. If this is happening in businesses all over the country, unemployment could get large quickly for entirely rational reasons.
Now, workers might realize their mistake and try to ask for lower wages. But this won’t get them hired either, because stepping out of the crowd to ask for a lower wage just sends a signal that you’re not worth very much and also that you’re unusual in some way. Employers won’t be interested in hiring a high-risk low-productivity worker. And furthermore, the workers know that employers will react in this way, so no individual will even bother trying.
Employers will see that people aren’t willing to work at the wage necessary to make it profitable to hire them and that they’re not budging on this. So they’ll start restructuring their business, substituting capital for the labor that has gone. Now you have a skills mismatch where the workers can’t do the sorts of things people are willing to pay them to do because the jobs they were trained for are now done by machines. And that can give you pretty persistent unemployment just with rational imperfect information microeconomics.
In the scenario you describe, the only reason workers “aren’t budging” is that they (correctly, it says here) anticipate that employers will fail to hire them at a profitable wage, due to the signalling effects of their reduced offer. Given that the employers are willing to restructure their businesses anyway, why don’t any of them restructure their hiring methods to make use of that cheaper labor pool?
Employers can do that, and they might. That would still take a while, however, and unemployment would persist in the meantime. This model isn’t a model of how unemployment would last forever, but only a way of showing that microeconomics has models that can produce a high level of unemployment without invoking irrationality.
But of course, employers might not do that as well. It depends: is it cheaper to restructure my business so that I don’t need those laborers, or is it cheaper to try to find out how to get those workers back indoors at a price I’m willing to pay? They’ve given me a pretty strong signal that the latter is going to be difficult. True, that signal was a result first of imperfect information and then a coordination problem, but that’s only obvious to the modeler. All the employer sees is that people walked out rather than take a pay cut and they’re not coming back even after learning that the economy in general is depressed.
Restructuring a business so that less labor is necessary seems like a more common activity than changing hiring practices so as to successfully lure workers back in. I hear about the former all the time, and I can’t recall a single instance of hearing about the latter, have you?
Not that this model is intended to actually explain anything that happens in reality, although it very well might. I don’t know. But it does show that rational microeconomic models can produce persistent high unemployment. This model can even lead to a fun Spiral of Doom where employees can’t get jobs because their old jobs are done by machines, so they need to go to school to learn new skills, but they can’t afford to go to school because they don’t have jobs, but they can’t get jobs because they don’t have any skills, but they can’t go to school...ad infinitum. Let’s hope there’s something about that model that’s very different from reality.
Restructuring a business so that less labor is necessary seems like a more common activity than changing hiring practices so as to successfully lure workers back in. I hear about the former all the time, and I can’t recall a single instance of hearing about the latter, have you?
If companies hiring employees at a lower wage than they used to pay is an example of this, then yes. If not, then I’m very confused.
In any case, I think I misunderstood your initial point and my confusion is entirely tangential to your actual point. Thanks for your clarification.
Yeah, no problem. Let me just add that lowering the wage they pay to workers is what employers tried in the first part of the model, and they received a very strong NO in response.
First of all, the division between micro- and macroeconomic models is essentially arbitrary. It’s not as if the economy itself cares about whether a phenomenon is micro- or macroeconomic. So even though I invoked aggregate demand, this model still seems microeconomic to me. There’s no money—the wages could be in coconuts for all the difference it would make. While what’s happening is economy-wide, that’s not relevant. When we talk about a simple kind of perfectly competitive economy, the slightest change in the cost of producing whatever the output is instantly has economy-wide effects, and yet that is certainly a microeconomic model. There’s no national accounting figures or any individual step in the argument that would make a 19th-century economist look at you funny.
If you don’t buy that then just substitute “the demand of a bunch of firms all fall at the same time” rather than “aggregate demand falls.” Now it’s microeconomics and totally unchanged.
Anyway, there are simpler ways of showing that rational microeconomics can produce high persistent unemployment. You can just ask why you expect the equilibrium level of price and quantity demanded of labor will be just happen to leave us with ~%5 unemployment. Then you might introduce a factor in addition to price and quantity that interferes with the operation of that simpler model. Information is an obvious candidate. Then you might read “The Market for Lemons” by George Akerloff and notice that there’s no reason that kind of model can’t apply to the labor market.
Basically, Joe Stiglitz would be surprised to learn that rational microeconomics doesn’t have models that can explain high persistent unemployment.
There could also be structural things going on in the economy. It’s easy to understand a model of the economy where what workers are capable of doing isn’t what anyone wants them to do, so they can’t get jobs. Their value to the economy might actually be zero, or information and signaling problems might make it impossible for workers to convince employers to hire them at a wage low enough to be worth it.
Now, workers might realize their mistake and try to ask for lower wages. But this won’t get them hired either, because stepping out of the crowd to ask for a lower wage just sends a signal that you’re not worth very much and also that you’re unusual in some way.
The fellow could be unusual in accurately assessing likely wage rates faster than his fellows. You’re making huge assumptions about the priors of the attitudes of employers.
For me the key Keynesian insights are:
The economy can be in equilibrium at a high level of unemployment.
People can choose more goods and less money, or more money and less goods. If they choose the in a sufficiently dramatic and surprising way, then you can end up with a general glut.
Of course both these arguments predate Keynes and Keynesian economics but nevertheless.
Microeconomics has its own ways of explaining persistent unemployment beyond the “natural rate” without invoking irrationality. These explanations have to do with a lack of information. They aren’t particularly new, either. Armen Alchian pioneered these models half a century ago.
Here’s an example of how things could go.
Aggregate demand drops, and so the employer, whose demand has also gone down, tries to lower the wages of his employees, who do not know that aggregate demand has dropped. They only see that their employer’s demand has dropped. They can rationally decide that it is worth quitting their job rather than taking they pay cut and looking for a job that will pay them what they think they are worth elsewhere. If this is happening in businesses all over the country, unemployment could get large quickly for entirely rational reasons.
Now, workers might realize their mistake and try to ask for lower wages. But this won’t get them hired either, because stepping out of the crowd to ask for a lower wage just sends a signal that you’re not worth very much and also that you’re unusual in some way. Employers won’t be interested in hiring a high-risk low-productivity worker. And furthermore, the workers know that employers will react in this way, so no individual will even bother trying.
Employers will see that people aren’t willing to work at the wage necessary to make it profitable to hire them and that they’re not budging on this. So they’ll start restructuring their business, substituting capital for the labor that has gone. Now you have a skills mismatch where the workers can’t do the sorts of things people are willing to pay them to do because the jobs they were trained for are now done by machines. And that can give you pretty persistent unemployment just with rational imperfect information microeconomics.
Wait, what?
In the scenario you describe, the only reason workers “aren’t budging” is that they (correctly, it says here) anticipate that employers will fail to hire them at a profitable wage, due to the signalling effects of their reduced offer. Given that the employers are willing to restructure their businesses anyway, why don’t any of them restructure their hiring methods to make use of that cheaper labor pool?
Employers can do that, and they might. That would still take a while, however, and unemployment would persist in the meantime. This model isn’t a model of how unemployment would last forever, but only a way of showing that microeconomics has models that can produce a high level of unemployment without invoking irrationality.
But of course, employers might not do that as well. It depends: is it cheaper to restructure my business so that I don’t need those laborers, or is it cheaper to try to find out how to get those workers back indoors at a price I’m willing to pay? They’ve given me a pretty strong signal that the latter is going to be difficult. True, that signal was a result first of imperfect information and then a coordination problem, but that’s only obvious to the modeler. All the employer sees is that people walked out rather than take a pay cut and they’re not coming back even after learning that the economy in general is depressed.
Restructuring a business so that less labor is necessary seems like a more common activity than changing hiring practices so as to successfully lure workers back in. I hear about the former all the time, and I can’t recall a single instance of hearing about the latter, have you?
Not that this model is intended to actually explain anything that happens in reality, although it very well might. I don’t know. But it does show that rational microeconomic models can produce persistent high unemployment. This model can even lead to a fun Spiral of Doom where employees can’t get jobs because their old jobs are done by machines, so they need to go to school to learn new skills, but they can’t afford to go to school because they don’t have jobs, but they can’t get jobs because they don’t have any skills, but they can’t go to school...ad infinitum. Let’s hope there’s something about that model that’s very different from reality.
If companies hiring employees at a lower wage than they used to pay is an example of this, then yes.
If not, then I’m very confused.
In any case, I think I misunderstood your initial point and my confusion is entirely tangential to your actual point.
Thanks for your clarification.
Yeah, no problem. Let me just add that lowering the wage they pay to workers is what employers tried in the first part of the model, and they received a very strong NO in response.
How can an argument which invokes ‘Aggregate demand’ be a micro-economic model?
First of all, the division between micro- and macroeconomic models is essentially arbitrary. It’s not as if the economy itself cares about whether a phenomenon is micro- or macroeconomic. So even though I invoked aggregate demand, this model still seems microeconomic to me. There’s no money—the wages could be in coconuts for all the difference it would make. While what’s happening is economy-wide, that’s not relevant. When we talk about a simple kind of perfectly competitive economy, the slightest change in the cost of producing whatever the output is instantly has economy-wide effects, and yet that is certainly a microeconomic model. There’s no national accounting figures or any individual step in the argument that would make a 19th-century economist look at you funny.
If you don’t buy that then just substitute “the demand of a bunch of firms all fall at the same time” rather than “aggregate demand falls.” Now it’s microeconomics and totally unchanged.
Anyway, there are simpler ways of showing that rational microeconomics can produce high persistent unemployment. You can just ask why you expect the equilibrium level of price and quantity demanded of labor will be just happen to leave us with ~%5 unemployment. Then you might introduce a factor in addition to price and quantity that interferes with the operation of that simpler model. Information is an obvious candidate. Then you might read “The Market for Lemons” by George Akerloff and notice that there’s no reason that kind of model can’t apply to the labor market.
Basically, Joe Stiglitz would be surprised to learn that rational microeconomics doesn’t have models that can explain high persistent unemployment.
There could also be structural things going on in the economy. It’s easy to understand a model of the economy where what workers are capable of doing isn’t what anyone wants them to do, so they can’t get jobs. Their value to the economy might actually be zero, or information and signaling problems might make it impossible for workers to convince employers to hire them at a wage low enough to be worth it.
The fellow could be unusual in accurately assessing likely wage rates faster than his fellows. You’re making huge assumptions about the priors of the attitudes of employers.