Conservative economists tend to believe that the capitalist economy will automatically create jobs for those who are willing and able to work at the equilibrium market wage and that equilibrium is a win/win situation for employers and employees. Equilibrium is said to be in the market when “the quantity supplied and the quantity demanded for a particular good are equal at a particular price” (Sherman et al. 309). When the market is at equilibrium price, people are able to buy or sell everything that they would like to buy or sell within their particular budget. When the market is not at equilibrium, this is not possible.
One way in which the market is not in equilibrium is if there is an excess supply. An excess supply is when a “price higher than the equilibrium price is established” (Sherman et al. 309). When there is an excess supply in the marketplace, the sellers tend to become frustrated because their inventories are bloated, leading them to have to lower their prices in order to sell more inventory. A labor supply curve shows the “number of hours of work that will be offered at various wage rates” (Sherman et al. 376). At low wages, the labor supply curve is sloping upwards because the substitution effect is stronger than the income effect. At an extremely high wage rate, the labor supply curve may end up turning backwards because the income effect is stronger than the substitution effect. For reference, the substitution effect is the notion that as prices increase or income decreases, consumers will substitute expensive items with cheaper alternatives. The income effect is the notion that a consumer’s income changes the demand of a good or service.
The other way in which the market is not in equilibrium is if there is an excess demand. An excess demand is when the “price established [is] below the equilibrium price” (Sherman et al. 310). When there is an excess demand in the marketplace, the buyers tend to become frustrated because the inventory is simply unavailable at the fixed price. A labor demand curve shows the quantity of workers that are hired at differing wage rates. As wages fall in the labor demand curve, the number of workers hired increases (Sherman et al. 375).
When the market is in equilibrium, it is a win/win for both the employers and employees because the employers do not have to raise or lower their prices, and the employees do not have to make more or less money than what they are already making. When the market is not in equilibrium, this is not possible, as the employers must either raise the prices if the demand is too high, or lower the prices if the demand is too low. Furthermore, when the market is not in equilibrium, the employees must either bring in more income if the supply is low, or does not have to bring in more income if the supply is too high. As a result, when the marketplace is in equilibrium, everyone is better off, because there will be neither an excess supply or an excess demand.
The market will always tend to be in equilibrium according to conservative economists. This is because either the sellers or the buyers will be forced to adapt to the other. A prime example of this situation would be Ford Explorers. In this scenario, the equilibrium price is $25,000. If Ford sets the price of Explorers at $30,000, this would lead to an excess supply because Ford will realize that at this established price, they are incapable of selling the number of Explorers that they had wanted. Once Ford realizes this, they will lower the price down to the equilibrium price of $25,000. However, if Ford set the price of Explorers at $20,000, there would be an excess demand. When there is an excess demand for Explorers, the price a consumer is willing to pay increases. This will lead to an increase in the set price until the price reaches the equilibrium price of $25,000. Evidently, the market will always tend to be in equilibrium, according to Neoclassicals (Sherman et al. 309-311).
Keynesian economists disagree with the Neoclassical view regarding full employment. Keynesian economists believe that there are no such thing as automatic self-adjustment mechanisms. They believe that decreasing prices and wages do not successfully increase investment and consumption. Instead, Keynes actually believe that the decreasing of prices and wages actually decrease investment and consumption as a result (“Keynesian Economics” Packet).
Keynesian economists have several counter arguments against the Neoclassicals claim that there is always full-employment equilibrium. Neoclassicals argue that when the demand for goods and services declines, prices will decline. When the prices decline, the demand will again rise to the equilibrium full-employment level. Keynes counter this claim by stating that when wages decrease in the economy, an abundance of employees have less capital, which results in consumer demands decreasing. This decrease in consumer demand stops the economy from recovering to full employment (Sherman et al. 489). Neoclassicals also believe that a decrease of labor demand will result in decreased wages and salaries. When this wage rate decreases, it is profitable to hire additional workers, leading the employment rate to go back to equilibrium at the decreased wage rates (489). Keynes counter this by stating that decreased wages cause lower consumer demand, leading there to be no automatic recovery to full employment (489). Finally, Neoclassicals believe that “lower investment means less demand for loans from bankers” (489). The lower the demand for loans causes interest rates to decrease. Lower interest rates will lead to more investment, which brings it back to equilibrium with savings. The overall consumer demand and investment demand will equal the overall supply, bringing the economy back to full-employment equilibrium (489). Keynes argued this claim by showing that investment is determined by the assumption of profits. If the assumed profits from an investment are lower than zero, nobody will invest. If the total profit declines, the investment will also continue to decline, regardless of how much the interest rate decreases (489).
Say’s Law states that “any amount supplied to the market will always generate an equal amount of demand” (Sherman et al. 15). Keynes believed that there is an absence of effective demand in the entire economy. Essentially, in the aggregate, output and income may or may not match spending. Keynes proved that the equilibrium level of the economy can be both at a state of mass unemployment or unduly full employment and inflation by using the Great Depression as an example.
Keynes argued that Neoclassicals was a special case because Neoclassicism was most popular and mainstream from the 1890’s to the Great Depression in the 1930’s (“Mainstream/Neoclassical Economics” Packet). The Great Depression changed the overall outlook on Neoclassicism. Keynes pointed out the flaws in the Neoclassical theory and showed that his theory was not a special, specified case, like the Neoclassical theory.
On the Bureau of Labor Statistics website, it shows that there is currently 3.9% unemployment in the United States. This is the first time the unemployment rate in the US has changed since October of 2017. From October of 2017 to March of 2018, the unemployment rate had stagnated at 4.1% (“Bureau of Labor Statistics Data” 2018). The US economy is not currently at full employment. However, it has been on a slow, gradual decline for nearly every month for the past 15 months. If the United States stays at the current pace it is on, full employment will not be reached for approximately another six years.