NeoKeynesian Models
Keynes wanted to explain involuntary unemployment, particularly involuntary
employment that lasts for a long time. One way of doing that is to simply assert
that the labor market doesn’t clear due to a wage rigitidy.
Figure 1. The Keynesian rigid wage model
Another Keynesian view was that workers used adaptive expectations in
formulating price expectations that would prevent the labor market from rapidly
adjusting to the equilibrium wage. In the case of the rigid wage model
involuntary unemployment will exist until prices increase sufficiently to drive the
labor demand curve far enough to the right to establish full employment.
The neoKeynesians would agree with the neoclassical economists and the RBC
economists that microeconomic fundamentals should be incorporated into
macroeconomic models. That being the case they try to show how these
rigidities can arise when agents optimize.
Some of the new Keynesian views involve
1. Assuming that some firms, at least, have market power. Previously we
had assumed that firms operated in a competitive economy.
2. Assume that price rigidities as well as wage rigidities exist.
3. Consider real rigidities as well as nominal rigidities. The rigid wage model
we looked at is in nominal terms.
Earlier Keynesians assumed that markets for output were perfectly competitive.
They did not necessarily believe this but used that assumption for simplicity so
they could concentrate on what they believed to be the primary culprit—rigid
money wages. The neoKeynesians include these other rigidities.
Sticky Price (Menu cost) Models
In a competitive (auction model) firms can sell as much as they wish at the
market price. They can sell nothing above the market price (given that
information is perfect buyers can always find sellers with a lower price).
Agricultural products are sold in auction markets –the price of this output
changes every day (prices will be close to the previous days prices but not the
same). Actually this is changing. Now farmers often sell output by contract to be
fulfilled at a future date. The contract may specify that that the farmer will receive
$5 for each bushel of wheat delivered in the fall.
Many, perhaps most goods do not fit the perfect competition model exactly. The
prices of most goods don’t change daily. The costs of changing prices may
outweigh the benefits of changing prices. These sort of costs are called menu
costs—restaurants don’t change prices every day because of the cost of making
new menus. While a restaurant might succeed in attracting some customers
away from other restaurants with daily price changes it is unlikely that it would
benefit much over those that changed prices, say, every 3 months. Note that the
costs of printing the menus is small compared to the cost of obtaining the
information about what to print.
One problem with changing costs daily is that people become irritated with price
increases. Which would customers prefer: (a) that you keep prices the same
over a three month period or (b) change them daily in response to supply and
demand? Many customers might prefer the certainty.
Automobile manufacturers are very reluctant to lower prices. If they lower prices
then other manufacturers will lower prices as well. It could be the case that all of
them sell about the same number of cars as before the price decrease. So they
end up with about the same market share at a lower price. There is a tendency
in the automobile industry to keep prices fixed. Even when they lower prices
they often refuse to admit that is what they are doing – they give rebates.
Automobile manufactures usually reduce output before than lowering prices. So
in the face of a decrease in demand they will reduce employment.
Efficiency Wage Models
These are sticky real wage models as opposed to the older sticky nominal wage
models. The idea is that employers may find it profitable to pay above market
wages in some cases. The benefits the firm may get are
1. Workers may worker harder because they fear that they will not get a job
that pays as well if they lose their current job (the shirking model).
2. Hiring new workers is expensive. Firms face recruiting and training costs.
Even on the job training costs can be expensive. Many new workers don’t
have sufficient skills to earn their keep until they learn these skills. You
can avoid these costs by keeping existing workers by paying higher than
market wages (the turnover model).
3. Happy workers are productive workers. A wage rate higher than the
market wage rate makes them happy (the gift exchange model).
So it may be profitable for some firms or some industries to offer higher than
market wages. Consider an unemployed worker hunting a job. This worker may
refuse employment from a firm offering market wages in hopes of finding one
from a firm offering higher than market wages. This is involuntary
unemployment.
Insider—Outsider Models
Insiders are workers with good high paying jobs (typically union jobs). These
workers can negotiate with management through their union and have market
power. Many trade unions ran apprenticeship programs at one time. If you
wanted to get the skills necessary to work in that trade you had to belong to the
union. The union could regulate the number of skilled workers and this would
give them market power in determining wages. Insiders could make it very
difficult for outsiders to get the skills necessary to work at a trade. Insiders may
also picket outsiders who try to undercut them by offering to work at a lower
wage. Insiders will try to use market power to increase their wages above the
market clearing wage. This will result in involuntary unemployment (or
underemployment) by some outsiders who cannot get insider jobs.
If aggregate demand falls and insiders refuse to lower their wages some insiders
will lose their jobs (become outsiders). There are now even fewer insiders and
these may be able to command either higher wages. The new outsiders will not
be allowed to become insiders again.
Structural labor market unemployment in Europe.