I like this post, because I find it very familiar, but it is familiar because it is reminiscent of the sorts of confusions and mix-ups that can result from half an economics education. And please allow me to push back on some points, to invite your further thoughts and considerations.
Just going in order, you treat classical economists as if they adhered to a revealed preference theory. That theory is Paul Samuelson’s, introduced at the tail end of neoclassical economics. It cannot explain anything the classical economists did. And in general, those who are happy not to work are not unemployed, they are nonemployed. Only people who want a job but cannot get one are unemployed, so the revealed preference explanation cannot explain unemployment in any case.
The classical economists did indeed blame a lot of unemployment on union activity and price floors. They were not wrong to do so, either. Both quite predictably create unemployment.
Irrationality is not a charge that should be thrown around lightly in economics. There is nothing about the traditional model of rationality that says people cannot tie their status to their nominal wealth. After all, it is really more a question of whether others do so, isn’t it? Nor is status necessary to invoke: workers are ignorant about the state of aggregate demand and their value to the company, so they use their coworkers and past experiences as references.
Some of the frictions you cite, such as changes in technology, are not frictions. Less productive workers are simply paid less, not unemployed.
Regarding all the difficulties of firing workers and changing jobs and so on, why doesn’t a series of markets emerge to address this very problem? If one can turn unemployed resources into employed resources, then one can potentially profit.
Alchian has a good paper or three on related subjects, am thinking it’s called “Information Costs,” but Google brings up the wrong paper.
Macroeconomics is not based on the observation that people spend what they earn. That observation is pretty old, probably older than economics itself, if you take Adam Smith as the starting point. And neither Keynesians nor monetarists really exist today. We understand now that Keynes and Old Keynesianism are basically wrong, and New Keynesianism incorporates those criticisms into a new research program.
Monetary theories of recession and unemployment go back to at least the days of Thomas Malthus, Jean-Baptiste Say, and John Stuart Mill. Then you have Jevons’s sunspots, the Austrian theory, and the rudimentary development of real business cycle theory as well, all before Keynes.
The circular flow model does not predict that a drop in spending creates a recession. The model just isn’t meant to do that. Markets have equilibrating properties that pull firms to discovering what consumers demand and making full use of resources. And It should be pretty obvious from experience that that mechanism must break down somewhere. Otherwise the next time you lose a penny the economy will collapse. It just does not describe any theory of unemployment, not even really the underconsumptionist theory. See the permanent income hypothesis for one example—Milton Friedman’s major break from Keynes.
You don’t mention real business cycle or new classical theory. They are rather academically dominant or recently were.
Since, as you seem to know, spending is income, reducing everyone’s income by 50% changes nothing. Everything goes down by 50%, and the economy is as it was before.
Of course people won’t work when the pay is too low. Or, if you think otherwise, will you please clean my bathroom every day for a dollar? Or point me to someone unemployed who will? And employers will not hire when the cost is too high—though I don’t doubt your bathroom-cleaning proficiency, I certainly wouldn’t pay you $100 for the service.
You don’t discuss the natural rate of unemployment at all.
No one is a Keynesian or a monetarist anymore, so most academic economists disagree with you about the business cycle. And I am not sure if even real business cycle theorists seriously will defend the argument that the oil shocks of the 70s caused a recession.
Thanks for your comments! It seems you are more knowledgeable in this field, so I’ll follow your views on most of these things (though I had read both papers you linked to).
The one thing I will disagree with is on terminology discussions. Nonemployment vs unemployment is not particularly useful, as its hard to observe the difference from the outside, and they overlap and can change within the same person (sometimes from day to day). And I know that some economists tie themselves in knots to avoid ever describing someone as “irrational”, but that’s entirely terminology—everyone agrees on what the behaviour is, and often on what motivates it, and the whole discussion is whether it merits the label rational or not. I personally prefer to use “irrational”, as it’s a useful descriptive term which would otherwise be almost empty of content. But that’s just a preference.
Oh, my pleasure. Economics is super neat and really changes the way you look at things, so I’m always super happy when someone gets into it and starts learning about this stuff. And then I write something super long telling them how super wrong they are....
Actually, the distinction between unemployed and nonemployed is very important. First of all, the blurring of terminology leads to more of the same, as some of the comments about frictions show. And more to the point, whether someone is unemployed, in the economics jargon, is a question about how they relate to an equilibrating market price. All the questions of information, friction, and macroeconomic disturbances boil down to the dynamics of this system. As the comments show, by blurring the lines between nonemployment and unemployment, a very confused sort of analysis results where markets never clear, frictions are rampant and virtually insurmountable, and macroeconomics seems divorced from common experience.
As for irrational and rational, fine, words are...wordy, but in a post about economics, readers might understandably think that you are using the sense of irrationality peculiar to economics rather than the sense of irrationality peculiar to this site. And, as a matter of personal and observed experience, I think you will go a lot farther in economics by calling nothing irrational under all possible explanations have been exhausted—because in economics, whatever you intend to intend by the word, “irrational” means “I’m done here.” Trying to come up with reasons why an individual resisting a nominal wage decrease is actually rational can be very elucidating. Relative status is only one possible explanation, and it could be a proxy for more, um, financially motivations.
is a question about how they relate to an equilibrating market price.
And this is, to my mind, a misleading though possibly useful simplification. People exhibit path dependence, moods, have issues of pride, resentment, have possibly fluctuating principles and energy levels, etc. Pretending that there is a single market price at which someone would work at, and using this to distinguish between unemployed and nonemployed might be useful in a model, but is a mistake if taken as a view of reality (and can lead to excessive respect for concepts such as “revealed preferences”, which are are only partially true).
There’s a reason that people stereotype economics as over-simplified, and its because many people do use the models in an over-simplified manner.
I feel the same about “irrational”. Someone can be economically rational while behaving in a stupid, counter-productive, and biased fashion. However, because of the connotations of “rational” in everyday speech, some people seem to feel that that’s not possible.
People will work at many prices. I’ll work practically anything at a million dollars an hour, and even more so at a billion dollars an hour. There are rather fewer prices, however, that will equate quantity supplied to quantity demanded, where both quantity supplied and quantity demanded should be understood as points on a supply/demand schedule describing the amount people want to sell/buy at that particular price.
I’m working on a series of articles about economics I hope to start posting fairly soon. I’m sure you’ll find them interesting....
I like this post, because I find it very familiar, but it is familiar because it is reminiscent of the sorts of confusions and mix-ups that can result from half an economics education. And please allow me to push back on some points, to invite your further thoughts and considerations.
Just going in order, you treat classical economists as if they adhered to a revealed preference theory. That theory is Paul Samuelson’s, introduced at the tail end of neoclassical economics. It cannot explain anything the classical economists did. And in general, those who are happy not to work are not unemployed, they are nonemployed. Only people who want a job but cannot get one are unemployed, so the revealed preference explanation cannot explain unemployment in any case.
The classical economists did indeed blame a lot of unemployment on union activity and price floors. They were not wrong to do so, either. Both quite predictably create unemployment.
Irrationality is not a charge that should be thrown around lightly in economics. There is nothing about the traditional model of rationality that says people cannot tie their status to their nominal wealth. After all, it is really more a question of whether others do so, isn’t it? Nor is status necessary to invoke: workers are ignorant about the state of aggregate demand and their value to the company, so they use their coworkers and past experiences as references.
Some of the frictions you cite, such as changes in technology, are not frictions. Less productive workers are simply paid less, not unemployed.
Regarding all the difficulties of firing workers and changing jobs and so on, why doesn’t a series of markets emerge to address this very problem? If one can turn unemployed resources into employed resources, then one can potentially profit.
Joseph Stiglitz on information and the invisible hand.
Janet Yellen on efficiency wages and unemployment.
Alchian has a good paper or three on related subjects, am thinking it’s called “Information Costs,” but Google brings up the wrong paper.
Macroeconomics is not based on the observation that people spend what they earn. That observation is pretty old, probably older than economics itself, if you take Adam Smith as the starting point. And neither Keynesians nor monetarists really exist today. We understand now that Keynes and Old Keynesianism are basically wrong, and New Keynesianism incorporates those criticisms into a new research program.
Monetary theories of recession and unemployment go back to at least the days of Thomas Malthus, Jean-Baptiste Say, and John Stuart Mill. Then you have Jevons’s sunspots, the Austrian theory, and the rudimentary development of real business cycle theory as well, all before Keynes.
The circular flow model does not predict that a drop in spending creates a recession. The model just isn’t meant to do that. Markets have equilibrating properties that pull firms to discovering what consumers demand and making full use of resources. And It should be pretty obvious from experience that that mechanism must break down somewhere. Otherwise the next time you lose a penny the economy will collapse. It just does not describe any theory of unemployment, not even really the underconsumptionist theory. See the permanent income hypothesis for one example—Milton Friedman’s major break from Keynes.
You don’t mention real business cycle or new classical theory. They are rather academically dominant or recently were.
Since, as you seem to know, spending is income, reducing everyone’s income by 50% changes nothing. Everything goes down by 50%, and the economy is as it was before.
Of course people won’t work when the pay is too low. Or, if you think otherwise, will you please clean my bathroom every day for a dollar? Or point me to someone unemployed who will? And employers will not hire when the cost is too high—though I don’t doubt your bathroom-cleaning proficiency, I certainly wouldn’t pay you $100 for the service.
You don’t discuss the natural rate of unemployment at all.
No one is a Keynesian or a monetarist anymore, so most academic economists disagree with you about the business cycle. And I am not sure if even real business cycle theorists seriously will defend the argument that the oil shocks of the 70s caused a recession.
Yes, the media is pretty bad about this.
Thanks for your comments! It seems you are more knowledgeable in this field, so I’ll follow your views on most of these things (though I had read both papers you linked to).
The one thing I will disagree with is on terminology discussions. Nonemployment vs unemployment is not particularly useful, as its hard to observe the difference from the outside, and they overlap and can change within the same person (sometimes from day to day). And I know that some economists tie themselves in knots to avoid ever describing someone as “irrational”, but that’s entirely terminology—everyone agrees on what the behaviour is, and often on what motivates it, and the whole discussion is whether it merits the label rational or not. I personally prefer to use “irrational”, as it’s a useful descriptive term which would otherwise be almost empty of content. But that’s just a preference.
Oh, my pleasure. Economics is super neat and really changes the way you look at things, so I’m always super happy when someone gets into it and starts learning about this stuff. And then I write something super long telling them how super wrong they are....
Actually, the distinction between unemployed and nonemployed is very important. First of all, the blurring of terminology leads to more of the same, as some of the comments about frictions show. And more to the point, whether someone is unemployed, in the economics jargon, is a question about how they relate to an equilibrating market price. All the questions of information, friction, and macroeconomic disturbances boil down to the dynamics of this system. As the comments show, by blurring the lines between nonemployment and unemployment, a very confused sort of analysis results where markets never clear, frictions are rampant and virtually insurmountable, and macroeconomics seems divorced from common experience.
As for irrational and rational, fine, words are...wordy, but in a post about economics, readers might understandably think that you are using the sense of irrationality peculiar to economics rather than the sense of irrationality peculiar to this site. And, as a matter of personal and observed experience, I think you will go a lot farther in economics by calling nothing irrational under all possible explanations have been exhausted—because in economics, whatever you intend to intend by the word, “irrational” means “I’m done here.” Trying to come up with reasons why an individual resisting a nominal wage decrease is actually rational can be very elucidating. Relative status is only one possible explanation, and it could be a proxy for more, um, financially motivations.
Cheers!
And this is, to my mind, a misleading though possibly useful simplification. People exhibit path dependence, moods, have issues of pride, resentment, have possibly fluctuating principles and energy levels, etc. Pretending that there is a single market price at which someone would work at, and using this to distinguish between unemployed and nonemployed might be useful in a model, but is a mistake if taken as a view of reality (and can lead to excessive respect for concepts such as “revealed preferences”, which are are only partially true).
There’s a reason that people stereotype economics as over-simplified, and its because many people do use the models in an over-simplified manner.
I feel the same about “irrational”. Someone can be economically rational while behaving in a stupid, counter-productive, and biased fashion. However, because of the connotations of “rational” in everyday speech, some people seem to feel that that’s not possible.
People will work at many prices. I’ll work practically anything at a million dollars an hour, and even more so at a billion dollars an hour. There are rather fewer prices, however, that will equate quantity supplied to quantity demanded, where both quantity supplied and quantity demanded should be understood as points on a supply/demand schedule describing the amount people want to sell/buy at that particular price.
I’m working on a series of articles about economics I hope to start posting fairly soon. I’m sure you’ll find them interesting....