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pressure or persuasion, unemployment will disappear even if total
payroll has declined.
The following diagram will illustrate this process: (see Figure 1).
Quantity of Labor is on the horizontal axis; wage rate on the verti-
cal. DLDL is the aggregate demand for Labor; IE is the total stock
of labor in the society; that is, the total supply of labor seeking
work. The supply of labor is represented by vertical line SLSL
rather than by the usual forward-sloping supply curve, because we
Keynesian Criticisms of the Theory 49
may abstain from any cutting of hours due to falling wage rates,
and more important, because we are investigating the problem of
involuntary unemployment rather than voluntary. Those who wish
to cut back their hours, or quit working altogether when wage
rates fall, can hardly be considered as posing an unemployment
problem to society, and we can therefore omit them here.
In a free market, the wage rate will be set by the intersection of
the labor supply curve SLSL and the demand curve DLDL, or at
point E or wage rate 0I. The labor stock IE will be fully employed.
Suppose, however, that because of coercion or persuasion, the
wage rate is kept rigid so that it does not fall below 0A. The supply
of labor curve is now changed: it is now horizontal over AC, then
rises vertically upward, CSL. Instead of intersecting the demand for
labor at point E the new supply of labor curve intersects it at point
B. This equilibrium point now sets the minimum wage rate of 0A,
but only employs AB workers, leaving BC unemployed. Clearly,
the remedy for the unemployment is to remove the artificial prop
keeping the supply of labor curve at AC, and to permit wage rates
to fall until full-employment equilibrium is reached.13
Now, the critic might ask: suppose there is not only speculation
that will speed adjustment, but speculation that overshoots its mark.
The speculative demand for labor can then be considered to be
DsDs, purchasing less labor at every wage rate than the true
demand curve requires. What happens? Not unemployment, but
full employment at a lower wage rate, 0J. Now, as the wage rate
falls below underlying market levels, the true demand for labor
becomes ever greater than the supply of labor; at the new equi-
librium wage the gap is equal to GH. The enormous pressure of
this true demand leads entrepreneurs to see the gap, and they
begin to bid up wage rates to overcome the resulting shortage of
labor. Speculation is self correcting rather than self aggravating,
and wages are bid up to the underlying free-market wage 0I.
If speculation presents no problems whatever and even helps
matters when wage rates are permitted to fall freely, it accentuates
13
See Hutt, The Significance of Price Flexibility, p. 400.
50 America s Great Depression
the evils of unemployment as long as wages are maintained above
free-market levels. Keeping wage rates up or only permitting them
to fall sluggishly and reluctantly in a depression sets up among
businessmen the expectation that wage rates must eventually be
allowed to fall. Such speculation lowers the aggregate demand
curve for labor, say to DsDs. But with the supply curve of labor still
maintained horizontally at AC, the equilibrium wage rate is
pushed farther to the left at F. and the amount employed reduced
to AF, the amount unemployed increased to FC.14
Thus, even if total payrolls decline, freely falling wage rates will
always bring about a speedy end to involuntary unemployment.
The Keynesian linkage of total employment with total monetary
demand for products implicitly assumes rigid wage rates downward;
it therefore cannot be used to criticize the policy of freely-falling
wage rates. But even if full employment is maintained, will not the
declining demand further depress business? There are two answers
to this. In the first place, what has happened to the existing money
supply? We are assuming throughout a given quantity of money
existing in the society. This money has not disappeared. Neither,
for that matter, has total monetary spending necessarily declined.
If total payrolls have declined, something else has gone up: the
total retained by entrepreneurs, or by investors, for example. In
fact, given the total money supply, the total flow of monetary
spending will only decline if the social demand for money has increased.
In other words, if hoarding has increased. But an increase in
hoarding, in total demand for money, is, as we have seen, no social
14
Note that, in Figure 1, the SL SL line stops before reaching the horizontal
axis. Actually, the line must stop at the wage yielding the minimum subsistence
income. Below that wage rate, no one will work, and therefore, the supply curve
of labor will really be horizontal, on the free market, at the minimum subsistence
point. Certainly it will not be possible for speculative withholding to reduce wage
rates to the subsistence level, for three reasons: (a) this speculative withholding
almost always results in hoarding, which reduces prices all-round and which will
therefore reduce the equilibrium money wage rate without reducing the equilib-
rium real wage rate the relevant rate for the subsistence level, (b) entrepreneurs
will realize that their speculation has overshot the mark long before the subsis-
tence level is reached; and (c) this is especially true in an advanced capitalist econ-
omy, where the rates are far above subsistence.
Keynesian Criticisms of the Theory 51
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