Changes in Money-Wages

Book 5: Money-Wages and Prices

The Classical Theory assumed that:

• the economic system was self-adjusting on an assumed fluidity of money-wages
• rigidity is to be blamed on maladjustment

A reduction in money-wages might stimulate output, as the classical theory supposes.

But I analyze it differently.

Classical economics says that a reduction in money-wages will stimulate demand by reducing the price of the finished product.

• It will increase output and employment up to the point where the labour was reduced previously.

Thus, the reduction in money-wages will leave demand unaffected.

Some economists say that demand should not be affected. They argue that:

• aggregate demand depends on the quantity of money multiplied by the income-velocity of money and
• there is no reason why a reduction in money-wages would reduce either:
  • the quantity of money or
  • its income-velocity
• profits will go up because wages have gone down

I think that:

• the reduction in money-wages might affect the aggregate demand through its reducing the purchasing power of some of the workers.
• the real demand, of those whose money incomes have not been reduced, will be stimulated by the fall in prices
• the aggregate demand of the workers themselves will be likely increased by the increased volume of employment, unless the elasticity of demand for labour in response to changes in money-wages is less than unity.

Thus, in the new equilibrium there will be more employment.

It is from this type of analysis that I fundamentally differ.

How did economists arrive at this reasoning?

Every industry has a demand curve of the public’s demand for their products.

• The public has supply curves for the prices of products.

These curves lead to other curves such as:

• the demand curve for labour
• the elasticity of demand for labour.

Economists think that:

• we have a demand curve for labour in industry as a whole with the quantity of employment at different levels of wages.
• it does not matter whether it is in terms of money-wages or of real wages.

If we are thinking in terms of money-wages, we must correct for changes in the value of money.

• But this leaves the general tendency of the argument unchanged, since prices certainly do not change in exact proportion to changes in money-wages.

If this is the basis of the argument, then it is false.

The demand curves for particular industries can only be constructed on some fixed assumption as:

• to the nature of the demand and supply curves of other industries and
• to the amount of the aggregate effective demand.

It is wrong to transfer the argument to industry as a whole unless we also transfer our assumption that the aggregate effective demand is fixed.

• Yet this assumption reduces the argument to an ignoratio elenchi.

A reduction in money-wages while effective demand stay the same will lead to an increase in employment.

But will the reduction in money-wages be accompanied by:

• the same aggregate effective demand as before, measured in money or
• an aggregate effective demand which is not reduced in full proportion to the reduction in money-wages (i.e. which is somewhat greater measured in wage-units)?

But if the classical theory is not allowed to extend its conclusions of a specific industry to industry in general, it is unable to answer what will be the effect of a reduction in money-wages will have on employment.

• This is because it has no method of analysis to tackle the problem*.

Pigou’s Theory of Unemployment:

• gets out of the Classical Theory all that can be got out of it
• shows that this theory has nothing to offer, when it is applied to the problem of what determines the volume of actual employment as a whole.[1]

Our analysis has 2 parts:

1. We have explained that a reduction in money-wages does not directly increase employment.

2. Does a reduction in money-wages affect employment in a particular direction through its repercussions on these 3 factors?

The volume of employment is uniquely correlated with the volume of effective demand measured in wage-units.

The effective demand is the sum of the expected consumption and the expected investment. This cannot change if the following are all unchanged:

• the propensity to consume
• the schedule of marginal efficiency of capital
• the interest rate

If, without any change in these factors, the entrepreneurs were to increase employment as a whole, their profits will necessarily fall short of their supply-price.

• I will rebut the crude conclusion that a reduction in money-wages will increase employment “because it reduces the cost of production”

• This is because, while costs might be reduced, the demand for the product might also be reduced.

The entrepreneur will only increase employment:

• if the society’s marginal propensity to consume is equal to unity, or
  • This will leave no gap between:
    • the increment of income and
    • the increment of consumption.
• if there is an increase in investment corresponding to the gap between:
  • the increment of income and
  • the increment of consumption
    • This will only occur if the marginal efficiencies of capital curve has increased relatively to the interest rate.

At the best, the date of their disappointment can only be delayed for the interval during which their own investment in increased working capital is filling the gap.