Keynes - The General Theory - Chapter II - Sections III - VII

Section III: Keynes begins this section with a discussion surrounding the differences between a reduction of money-wages, and a reduction of real wages, "due to a change in the purchasing power of money which affects all workers alike." Keynes claims that although every other element in economics - such as prices - are set in real terms, people only care about money wages. It is quite a stretch for him to claim that unions and workers will accept falling real wages in the form of rising prices, as long as money wages remain the same. If this were the case, why do unions ask for raises to keep pace with inflation, and why does government grant its own employees a raise to compensate rising prices?

Section IV: Keynes uses this chapter to define involuntary unemployment. He writes, "Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relative to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment." At best, this describes frictional unemployment. If, as Keynes claims, the aggregate supply and the aggregate demand would be greater than the current condition the excess demand will employ the extra supply. Keynes' "problem" of involuntary unemployment is at worst a short-run case.

He goes on to argue that if the classical theory only applies to full unemployment, "it is fallacious to apply it to the problems of involuntary unemployment - if there be such a thing (and who will deny it?)" Considering Keynes wrote this during the Great Depression I doubt many of the thousands of unemployed would deny it, but that does not make it correct. Rather than making a case for involuntary unemployment, and arguing it against the classical theory, Keynes would rather appeal to people's emotions.

Section V: Keynes continues his discussion of wages and employment in this section. He argues that with a given organization, equipment, and technique, real wages and the volume of output are correlated. From this correlation he claims, "an increase in employment can only occur to the accompaniment of a decline on the rate of real wages." He continues, "if employment increases, then, in the short period, the reward per unit of labour in terms of wage-goods must, in general, decline and profits increase." This is not necessarily true, for if an entrepreneur increases employment he will pay the new workers according to the output he expects them to contribute. If he is wrong, and the worker contributes less than he believed, the entrepreneur will experience losses. One must not forget that employment is a voluntary agreement among two parties, and the only law governing their wage is each parties individual value scale.

Keynes ends this section with a claim that is essential to his theory, "a willingness on the part of labour to accept lower money-wages is not necessarily a remedy for unemployment." This is the basis for the Keynesian belief that the government must intervene via inflation to stop involuntary unemployment. Yet, inflation affects the entire economy, including prices, while allowing flexible wage rates only affects certain sectors of the economy. Surely, it is more efficient and less distortive to allow wages to fall and clear the market for a particular labor factor than to inflate prices throughout the economy.

Section VI: In this section Keynes tackles the classical theorists belief that supply creates its own demand. He quotes from both J.S. Mill and Marshall, but one point from Marshall is of particular importance, "He is said to spend when he seeks to obtain present enjoyment from the services and commodities of his which he purchases. He is said to save when he causes the labour and the commodities which he purchases to be devoted to the production of wealth from which he expects to derive the means of enjoyment in the future." This is consistent with the Austrian view that all economic activity revolves around satisfying the desires of the consumer; either now or in the future. Keynes disagrees with this belief, and claims that there is no link between decisions to abstain from present consumption and decisions to provide for future consumption. Unfortunately for Keynes, time preference clearly provides the link between present and future consumption decisions.

Section VII: In the final section of this chapter, Keynes outlines the three assumptions of the classical theory that he has purportedly refuted.