Question

Using the labor market graphs for both the classical and Keynesian models, please show the effects of a decrease in labor demand in the economy

Answer 1

Supply of labor ( Ls ) is determined by real wages in classical model ( W/ P ) .

Labor supplied and real wages are positively related .

The Keynesian labor supply differs from Classical theory because it includes individual those are outside the workforce . Hence , for a particular given real wage level Keynesian labor supply will be more than Classical . The difference is just that the Keynesian Ls curve will be right to Classical curve .

On the other hand demand for labor Ld , which also depends upon real wage and is inversely related to it , is same for both models . It is derived from marginal product concept , because we know that demand for labor or wage is equal to the value of marginal product of labor .

For Classical equilibrium real wage , the Keynesian supply will always be higher and exceed demand . The key assumption in Keynesian model is that it includes unemployment at equilibrium . The real wage in Keynesian model is not at equilibrium like Classical model , there is always an excess supply of labor at Keynesian equilibrium .

Now increase in labor demand in the economy moves the demand curve right . The Real Classical Equilibrium wage rises and also employment at equilibrium . The equilibrium for Keynesian model also rises but there will still be higher unemployment at equilibrium since higher real wage means more quantity supplied of labor also .