Keynesian models virtually always involve two key elements: (1) a monetary exchange economy, and (2) some kind of nominal price stickiness. (The simple income/expenditure model assumes no price adjustments at all; the full implications of imperfect price adjustment are only seen in AS/AD type models.) From a micro-economic perspective, there is no mystery: price stickiness is just like a binding price control, where the short side of the market determines quantity traded.
What the income/expenditure model adds is that, in the very short run, feedback loops can drive effective income/expenditure very far below their “notional” values (the values that would prevail in the absence of frictions), due to how desired expenditure depends on realized income.
Note that here, wage flexibility does not remove all frictions, because price stickiness also matters a lot. To a first approximation, adding wage flexibility would merely result in making wages sharply pro-cyclical (because labor demand also depends on realized income).
Keynesian models virtually always involve two key elements: (1) a monetary exchange economy, and (2) some kind of nominal price stickiness. (The simple income/expenditure model assumes no price adjustments at all; the full implications of imperfect price adjustment are only seen in AS/AD type models.) From a micro-economic perspective, there is no mystery: price stickiness is just like a binding price control, where the short side of the market determines quantity traded.
What the income/expenditure model adds is that, in the very short run, feedback loops can drive effective income/expenditure very far below their “notional” values (the values that would prevail in the absence of frictions), due to how desired expenditure depends on realized income.
Note that here, wage flexibility does not remove all frictions, because price stickiness also matters a lot. To a first approximation, adding wage flexibility would merely result in making wages sharply pro-cyclical (because labor demand also depends on realized income).