Saturday, October 30, 2004

Interesting bits in Keynes' General Theory, Part 1:

First things first: It's called the "General Theory" to distinguish it from the "Classical Theory."

Keynes thinks that the classical theory is only useful as a static theory: that is, it will work out the distribution of resources assuming that all of these resources are being fully employed.

"Fully employed" means that the economy is at the edge of the production possibilities frontier. It doesn't mean that there can be no further productivity gains if the frontier itself is expanded, for example by finding a way to make the labor market more flexible.

An economy is at full employment if the wage rate equals the marginal product of labor. That is, if the output generated by hiring the most recent worker is equal to his or her wage. At the same time, it must be the case that the wage equals the marginal disutility of labor. That is, that if you lower the wage just a tiny little bit, then workers are going to drop out of the labor force because it just isn't worth the trouble to show up at work.

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