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IPFS News Link • Economic Theory

Why Keynes Was Wrong about Unemployment

• By Robert Blumen

 Equilibrium is a state which markets will naturally move toward as buyers and sellers look for mutually advantageous exchanges. Firms can always get some value from additional labor, even under pessimistic forecasts of sale prices and quantities. Workers earning zero wages can improve their situation by accepting a job—even if they do not accept the first offer. Therefore, a labor market in surplus will absorb unemployed labor at a lower wage. When a market is in surplus, the direction the price must go toward equilibrium is down.

Or so it was thought before Keynes. Keynes's notion of unemployment equilibrium was a break with prior theory, which held that markets clear through price and quantity adjustments. When there is a surplus, a lower price is needed to clear a greater quantity of employment.