Involuntary unemployment

Involuntary unemployment occurs when a person is willing to work at the prevailing wage yet is unemployed. Involuntary unemployment is distinguished from voluntary unemployment, where workers choose not to work because their reservation wage is higher than the prevailing wage. In an economy with involuntary unemployment there is a surplus of labor at the current real wage. Involuntary unemployment cannot be represented with a basic supply and demand model at a competitive equilibrium: All workers on the labor supply curve below the market wage would voluntarily choose not to work, and all those above the market wage would be employed. Given the basic supply and demand model, involuntarily unemployed workers lie somewhere off of the labor supply curve. Economists have several theories explaining the possibility of involuntary unemployment including implicit contract theory, disequilibrium theory, staggered wage setting, and efficiency wages.

Models based on implicit contract theory, like that of Azariadis (1975), are based on the hypothesis that labor contracts make it difficult for employers to cut wages. Employers often resort to layoffs rather than implement wage reductions. Azariadis showed that given risk-averse workers and risk-neutral employers, contracts with the possibility of layoff would be the optimal outcome.

Efficiency wage models suggest that employers pay their workers above market clearing wages in order to enhance their productivity. In efficiency wage models based on shirking, employers are worried that workers may shirk knowing that they can simply move to another job if they are caught. Employers make shirking costly by paying workers more than the wages they would receive elsewhere. This gives workers an incentive not to shirk. When all firms behave this way, an equilibrium is reached where there are unemployed workers willing to work at prevailing wages.

Following earlier disequilibrium research including that of Robert Barro and Herschel Grossman, work by Edmond Malinvaud clarified the distinction between classical unemployment, where real wages are too high for markets to clear, and Keynesian unemployment, involuntary unemployment due to inadequate aggregate demand. In Malinvaud's model, classical unemployment is remedied by cutting the real wage while Keynesian unemployment requires an exogenous stimulus in demand. Unlike implicit contrary theory and efficiency wages, this line of research does not rely on a higher than market-clearing wage level. This type of involuntary unemployment is consistent with Keynes's definition while efficiency wages and implicit contract theory do not fit well with Keynes's focus on demand deficiency.

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