Are Rigid Prices the Cause of Unemployment?

The view of old and new mainstream economics that rigid wages are the single most important cause of unemployment rests on the assumptions of declining marginal productivity of factors of production and the substitution hypothesis which makes the entrepreneurs chose more labour-intensive techniques of production when wages fall in relation to the cost of capital. Kalecki and Keynes opposed that view and demonstrated that when the economy operates below full employment of factors of production, cuts in money wages either would have to be offset by corresponding reductions of prices to leave the purchasing power of worker households unaffected, or would result in a reduction of aggregate demand, and therefore of total output and employment. Notwithstanding some significant differences in their respective theories, both Kalecki and Keynes show that after cutting wages throughout the economy, capitalists have no reasons either to increase investments — since their additional profits take the form of accumulation of stocks of unsold consumer goods, and their capital equipment continues to idle below full capacity output — or to raise their consumption, which in turn largely depends on their profits. When imperfect competition and cartelized sectors are allowed for, reduction of wages reduces employment and output even more than under free competition.