Keynesian Economics
Introduction
According to the New Keynesian Economics, market may fail to clear due to wages and prices. In economics, all of the variables are associated with one another. In terms of governmental actions, the monetary policy and fiscal policy are good indication that somehow, the prices in the market are maintained and monitored. The common concept of letting the regulation over the prices of the products is to avoid the unnecessary inflation which is definitely a hardcore in the issues in the country such as the currency risks, unemployment, oil and wages and many more. Through the help of economics, the government and organizations are agreed to have a control for both price rigidities and wage rigidities.
The Early and New Keynesian Economics
The Keynesian view of business cycles in 1980 was clouded with too many doubts. The problem was not new empirical evidence against Keynesian theories, but weakness in the theories themselves. According to the Keynesian view, fluctuations in output arise largely from fluctuations in nominal aggregate demand. These changes in demand have real effects because nominal wages and prices are rigid. But in Keynesian models have the crucial nominal rigidities were assumed rather than explained-assumed directly, as in disequilibrium models, or introduced through theoretically arbitrary assumptions about labor contracts. Indeed, it was clearly in the interests of agents to eliminate the rigidities they were assumed to create. If wages, for example, were set above the market-clearing level, firms could increase profits by reducing wages. Therefore, the early introduction of Keynesian Economics and its associated theories led the way for the economists to move toward the new classical models with flexible wages and prices – the New Keynesian Economics.
The primary disagreement between new classical and new Keynesian economists is over how quickly wages and prices adjust. New classical economists build their macroeconomic theories on the assumption that wages and prices are flexible. They believe that prices “clear” (e.ge supply and demand) by adjusting quickly. New Keynesian economists, however, believe that market-clearing models cannot explain short-run economic fluctuations, and so they advocate models with “sticky” wages and prices. New Keynesian theories rely on this stickiness of wages and prices to explain why involuntary unemployment exists and why monetary policy has such a strong influence on economic activity.
Application of New Keynesian Economics
In the price system, the adjustment of prices to changes in market conditions is the primary mechanism by which markets function and by which the three most basic questions get answered: what to produce, how much to produce and for whom to produce. To the behavior of price and price system, therefore, have fundamental implications for many key issues in microeconomics and industrial organization, as well as in macroeconomics and monetary economics. In microeconomics, managerial economics, and industrial organization, economists focus on the price system efficiency. In macroeconomics and monetary economics, economists focus on the extent to which nominal prices fail to adjust to changes in market conditions. Nominal price rigidities play a particularly important role in modern monetary economics and in the conduct of monetary policy because of their ability to explain short-run monetary non-neutrality. The behavior of prices, and in particular the extent of their rigidity and flexibility, therefore, is of central importance in economics.
In unemployment issue, normally, economists presume that an excess supply of labor would exert a downward pressure on wages. A reduction in wages would in turn reduce unemployment by raising the quantity of labor demanded. Hence, according to standard economic theory, unemployment is a self-correcting problem. New Keynesian economists often turn to theories of what they call efficiency wages to explain why this market-clearing mechanism may fail. These theories hold that high wages make workers more productive. The influence of wages on worker efficiency may explain the failure of firms to cut wages despite an excess supply of labor and should emphasize the productivity on labor and profit on the organization.
Conclusion
The unemployment in South Africa is one of the common problems that most of the regions endure. But because of the new Keynesian economics, it suggests that the macroeconomic theory being applied by the government should be matched with the fiscal policy. This might not be the most applicable solution for the unemployment rates but it is good foundation in stabilizing the labor market and coordinate with the efficiency wages. The decision should be made on whether policymakers should intervene in practice, however, is a more difficult question that entails various political as well as economic judgments.
References:
Ball, L., Mankiw, N.G., & Romer, D., (2007) The New Keynesian Economics and the Output- Inflation Trade-08 [Online] Available at: http://www.economics.harvard.edu/faculty/mankiw/files/New_Keynesian.pdf [Accessed 13 August 2010]
Holzer, H.J., (1996) Employer Demand, AFDC Recipients, and Labor Market Policy, Institute for Research on Poverty [Online] Available at: http://www.irp.wisc.edu/publications/dps/pdfs/dp111596.pdf [Accessed 13 August 2010].
Levy, D., (2007) Price Rigidity and Flexibility: Recent Theoretical Developments, Managerial and Decision Economics, Vol. 28 [Online] Available at: http://www.biu.ac.il/soc/ec/d_levy/wp/mde2.pdf [Accessed 13 August 2010].
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