How are we to explain a stable or “equilibrium” condition with an excess supply of labor?
In the simple Keynesian model of production, we have not mentioned employment or unemployment at all — but that’s the point, really. In this sort of equilibrium, equilibrium production is what it is, regardless whether it is enough production to employ all the people who are looking for jobs. The number of workers employed will be, at most, the equilibrium production divided by the average productivity of labor. This gives us three possible outcomes.
- Equilibrium production divided by productivity is less than the labor force.
- In this case, there will be unemployment. There will only be enough jobs to produce the equilibrium production, and the rest of the labor force will be unemployed. In the economist’s jargon, this is called a “recessionary gap.” The idea is that production is usually below the full-employment level in a recession.
- Equilibrium production divided by productivity is more than the labor force.
- In this case, equilibrium production will be unattainable. Economists have traditionally thought of this as an inflationary situation, since businessmen would plan to produce more, and would compete with one another to hire labor to produce at the level they have planned. There not being enough labor to go round, wages would rise, and prices would follow them up –without any limit, so far as the simple model is concerned. Therefore, this case is called an “inflationary gap.”
- Equilibrium production divided by productivity is just equal to the labor force.
- There would be exactly “full employment.” This would either be a lucky coincidence, and unstable, or the result of careful government support of the economy, according to strict “Keynesian” economists. Neoclassical economists would say that market forces — among the things we have left out of the model as simplifying assumptions — would bring the economy precisely to this “coincidence.” There is plenty of controversy here.
- Source: Encyclopedia Britannica