New Directions in Modern Economics series
Chapter 5: The Nature of the Labor Market
AGGREGATE DEMAND AND SUPPLY A further step towards an integrated approach consists not only in considering a monetary economy of production where real and monetary aspects are present, but also in taking into account the interdependence between aggregate demand and supply. As is well documented in the history of macroeconomics, the two aspects have experienced a period of supremacy but they have very seldom enjoyed a state of integration. The neo-classical paradigm has always insisted on the role of aggregate supply, while the Keynesian approach has stressed aggregate demand more. The fact that a paradigm has privileged one aspect with respect to the other does not mean that the latter was absent: it was only passive. In fact, in the neo-classical world, demand is present, but it is only a reflection of production: Say’s law is at work in this paradigm. In the Keynesian model, demand drives the economy, with supply simply adjusting. In the Real Business Cycle version of neo-classical economics, aggregate supply is vertical not only in steady state, but also in the short run. It follows that in this case, only supply-side policies matter: the compromise of the ‘new neo-classical synthesis’ model breaks down. The verticality of this curve depends mainly on two assumptions: a particular nature of the labor market and the assumption of rational expectations. In this chapter, the first aspect will be considered, while the second will be questioned later on. 2. THE LABOR MARKET AND THE SUPPLY CURVE In order to understand the...
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