Money Wage Rate Vs Real Wage Rate
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Keynes's theory of wages and prices is contained in the three chapters 19-21 comprising Book V of The General Theory of Employment, Interest and Money.

The role of Book V in Keynes's theory[edit]

Chapter 19 discusses the question of whether wage rates contribute to unemployment. Keynes's views and intentions on this matter have been vigorously debated, and he does not offer a clear answer in this chapter. The concept of the Keynes effect arises from his attempts to resolve the issue.

Chapter 20 covers some mathematical ground needed for Chapter 21. Chapter 21 considers the question of how a change in income resulting from an increase in money supply will be apportioned between wages, prices, employment and profits. (The results also depend on the exogenous behaviour of the workforce and on the shapes of various functions.)

Similar considerations arise within the body of Keynes's theory since an increase in income due to a change in the schedule of the marginal efficiency of capital will have an equally complicated effect. When the topic arose in Chapter 18 Keynes did not mention that a full analysis needed to be supported by a theory of prices; instead he asserted that 'the amount of employment' was 'almost the same thing' as the national income.^[1] They are different things but under suitable assumptions they move together. Schumpeter and Hicks appear to have taken Keynes's comment at face value, concluding from it that the General Theory analysed a time period too short for prices to adapt, which deprives it of any interest.^[2]

Brady and Gorga view Chapters 20 and 21 as providing belated elucidation of the aggregate demand presented earlier in the book, particularly in Chapter 3.^[3]

Chapter 19: Changes in money wages[edit]

Contrast with classical view[edit]

Keynes summarizes the view of classical economists that the economy should be self-adjusting if wages are fluid, and that they blame rigidity in wages for problems like unemployment. He disagrees with what he says is the orthodox view, based on the quantity theory of money, is that wage reductions have a small effect on aggregate demand, but that this is made up for by demand for other factors of production.^[4] Keynes postulates that the classical position has reached a mistaken conclusion by analysing the demand curve for a given industry and transferring this conception 'without substantial modification to industry as a whole'.^[5] Keynes specifically disagrees with the theory of Arthur Cecil Pigou 'that in the long run unemployment can be cured by wage adjustments' which Keynes did not see as important compared to other influences on wages.^[6]

Keynesian analysis[edit]

Keynes considers seven different effects of lower wages (including the marginal efficiency of capital and interest rates) and whether or not they have an impact on employment.^[7]He concludes that the only one that does is interest rates.^[8] This indirect effect of wages on employment through the interest rate was termed the 'Keynes effect' by Don Patinkin. Modigliani later performed a formal analysis (based on Keynes's theory, but with Hicksian units) and concluded that unemployment was indeed attributable to excessive wages.^[9]

Keynes argued that interest rates can also be reduced by increasing the supply of money^[10] and that this is more practical and safer than a widespread reduction in wages, which might need to be severe enough to harm consumer confidence^[11] which would itself increase unemployment because of reduced demand. He summarises:

There is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment;– any more than for the belief that an open-market monetary policy is capable, unaided, of achieving this result. The economic system cannot be made self-adjusting along these lines.^[12]

And having come to the view that 'a flexible wage policy and a flexible money policy come, analytically, to the same thing', he presents four considerations suggesting that 'it can only be an unjust person who would prefer a flexible wage policy to a flexible money policy'.^[13]

Axel Leijonhufvud attached particular significance to this chapter, adopting the view in his 1968 book Keynesian economics and the economics of Keynes that its omission from the IS-LM model had pointed Keynesian economics in the wrong direction. He argued that:

His [Keynes's] followers understandably decided to skip the problematical dynamic analysis of Chapter 19 and focus on the relatively tractable static IS-LM model.^[14]

Chapter 20: The employment function[edit]

Chapter 20 is an examination of the law of supply. Keynes makes use for the first time of the 'first postulate of classical economics', and also for the first time assumes the existence of a unit of value allowing outputs to be compared in real terms. He depends heavily on an assumption of perfect competition, which indeed is implicit in the 'first postulate'. An important difference is that when competition is not perfect, 'it is marginal revenue, not price, which determines the output of the individual producer'.^[15] Keynes interprets the relation between output and employment as a causative relation between effective demand and employment. He discusses what happens at full employment^[16] concluding that wages and prices will rise in proportion to any additional expenditure leaving the real economy unchanged. The money supply remains constant in wage units and the rate of interest is unaffected.

Chapter 21: The theory of prices[edit]

The purpose of this chapter is to examine the effect of a change in the quantity of money on the rest of the economy. Keynes does not provide a conclusive statement of his views, but rather presents an initial simplification followed by a number of corrections.

Keynes's initial simple model[edit]

Keynes's simplified starting point is this: assuming that an increase in the money supply leads to a proportional increase in income in money terms (which is the quantity theory of money), it follows that for as long as there is unemployment wages will remain constant, the economy will move to the right along the marginal cost curve (which is flat) leaving prices and profits unchanged, and the entire extra income will be absorbed by increased employment; but once full employment has been reached, wages, prices (and also profits) will increase in proportion to the money supply. This is the 'modified quantity theory of money'.

Quantity theory of money[edit]

Keynes does not accept the quantity theory. He writes effective dema

Money Wage Vs Real Wage