Why do people work? At first it seems an easy question – to get money or earn income is the answer that comes quickly to mind. Indeed, mainstream neo-classical micro economic theory answers the question this way and uses it to build a model where people (households) make decisions about how much to work (called “labor supply”) as a function of the real wage offered. There’s a counterpart model where business firms decide how many workers to hire based on the real wage and it’s called “marginal productivity theory”. It results in a “labor demand” curve. Like moths drawn to lights, when economists are given a “supply” curve and a “demand” curve we must see where they intersect, label that equilibrium, and say all’s well, the market solves everything. We then proceed to use our equilibrium result as block in building an even larger theory or model. And, in fact, that happens with labor demand and supply. It becomes a critical part of some mainstream (mostly Classical based) macroeconomic theories.
Unfortunately, this little example also shows economists behaving badly, or at least illogically and unscientifically. Let’s go back to the beginning. It’s a huge assumption and leap of faith (or ideology) to go from the casual observation that most people prefer (or need) to get paid for their work to assuming, as mainstream theory does, that money is the only reason people work. An even greater leap is the assumption that there is a quantitative relationship between real wage rate and the amount of work people are willing to offer. The mainstream economists assume that work is necessarily a negative, disutility-creating experience. But that is not a logic inference from the observation that people like to or insist on getting paid for work. It is entirely plausible that people find work a necessary, fulfilling part of life – after all many people are observed to continue working even when they don’t need it financially. If may be that people want balanced lives – a mix of work, leisure, and hygiene. It may be a mix of these factors. Indeed, research in management and psychology fields suggests it is.
But economists persist in the simplified theory. Unfortunately this leads to misunderstandings and bad models when the economists tackle larger problems like unemployment. Bill Mitchell notes:
The simplest version is that labour supply in the mainstream model (and complex versions don’t add anything anyway) says that households equate the marginal disutility of work (the slope of the labour supply function) with the real wage (indicating the opportunity cost of leisure) to determine their utility maximising labour supply.
So in English, it is assumed that workers hate work and but like leisure (non-work). They will only go to work to get an income and the higher the real wage the more work they will supply because for each hour of labour supplied their prospective income is higher. Again, this conception is arbitrary and not consistent with countless empirical studies which show the total labour supply is more or less invariant to movements in the real wage.
Other more complex variations of the mainstream model depict labour supply functions with both non-zero real wage elasticities and, consistent with recent real business cycle analysis, sensitivity to the real interest rate. All ridiculous. Ignore them!
In the mainstream model, labour market clearing – that is when all firms who want to hire someone can find a worker to hire and all workers who want to work can find sufficient work – requires that the real wage equals the marginal product of labour. The real wage will change to ensure that this is maintained at all times thus providing the classical model with continuous full employment. So anything that prevents this from happening (government regulations) will create unemployment.
If a worker is “unemployed” then it must mean they desire a real wage that is excessive in relation to their productivity. The other way the mainstream characterise this is that the worker values leisure greater than income (work).
Macroeconomists, thinking they have firmly built a macro theory on some “micro foundations”, assume that involuntary unemployment (the kind where you want a job but can’t find a job) simply doesn’t exist unless people are insisting on getting paid too much. It’s absurb, but that has become the foundation of not only macro theory, but micro theories of distribution of income, and modern policy.