Econ102 Transportation Logistics Management

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Classical economists belief that prices and quantities adjust to the changes in the forces of supply and demand and that the economy produces its potential output in the long run.  On the contrary, Keynesian economists believe because of price and wage rigidities the economy’s equilibrium output in the long run may be less than its potential output.  What is price-wage rigidity?  Do you agree with Keynes assessment that wage-price rigidity requires government’s involvement in the markets?  Why?  Why not?


Price-wage rigidity is when prices and wages does not change to the equilibrium. Sometimes wages are locked into contract and cannot change until the contract is up. This does not allow for wages to move until later. Prices may not change because companies can wait and see if the prices either go back down or up. Companies can have the challenge of trying not to lose their customers by raising prices.
I agree with Keynes assessment that wage-price rigidity requires government involvement. When real wage exceeds the equilibrium value it will cause lower employment rate than the natural level. The resulting lower employment rate means that more people are looking for jobs than necessary. The unemployed will not be putting money back into the economy causing it to take longer to reach equilibrium. The government can intervene by lowering interest rates or increase spending trying to decrease the gap from the equilibrium. There are sometimes the government tries things that do not really affect the economy. For example, the government tried to give rebates and it had no impact on the economy. The plan was to give money back to increase spending. The result is not always what they think is going to happen. Some can argue that they should have let the economy naturally corrected itself. There are good and bad that can happen when trying to close the gaps in the economy. It is something that is always argued and just matters on how quickly people should feel the gaps should be there.


Classical economic theory states that a change in supply will create an equal and reciprocal change in demand. This theory is based on the assumption that the economy fully uses all available resources for production, especially labor, and that all earned income is spent on goods and services. In this economic model, wages and prices can freely adjust upwards or downwards and the economy is self-correcting without the need for government action or policy change. While classical economic theory may seem sound in theory, it has several flaws when practically applied to real world economies. These issues were addressed by John Maynard Keynes’ economic theories.  In Keynesian economics the interplay of supply and demand is reverse in comparison to classical economics. Keynes theory states that a change in demand will cause a change in supply. Keynesian economics also takes into account the realistic fact that an economy does not use all of its available resources, which means that involuntary unemployment exists, in addition to the fact that not all earned income is spent on goods and services. Therefore, in the Keynesian model, prices and wages do not fluctuate to the same degree as they would in the classical model. This is knows is price-wage rigidity and is caused by the propensity for businesses to reduce production, as opposed to reducing price levels, as well as the tendency for workers to resist wage cuts. All of these factors lead to the eventuality that the government will be required to step in to abate downward trends in a nation’s economic cycle.

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