1. NeoKeynesian Models
Keynes wanted to explain involuntary unemployment, particularly involuntary employment
that lasts for a long time. One way of doing that is to simply assert that the labor market
doesn’t clear due to a wage rigitidy.
Figure 1. The Keynesian rigid wage model
Another Keynesian view was that workers used adaptive expectations in formulating price
expectations that would prevent the labor market from rapidly adjusting to the equilibrium
wage. In the case of the rigid wage model involuntary unemployment will exist until prices
increase sufficiently to drive the labor demand curve far enough to the right to establish full
employment.
The neoKeynesians would agree with the neoclassical economists and the RBC economists
that microeconomic fundamentals should be incorporated into macroeconomic models. That
being the case they try to show how these rigidities can arise when agents optimize.

2. Some of the new Keynesian views involve
1. Assuming that some firms, at least, have market power. Previously we had assumed
that firms operated in a competitive economy.
2. Assume that price rigidities as well as wage rigidities exist.
3. Consider real rigidities as well as nominal rigidities. The rigid wage model we looked
at is in nominal terms.
Earlier Keynesians assumed that markets for output were perfectly competitive. They did not
necessarily believe this but used that assumption for simplicity so they could concentrate on
what they believed to be the primary culprit—rigid money wages. The neoKeynesians
include these other rigidities.
Sticky Price (Menu cost) Models
In a competitive (auction model) firms can sell as much as they wish at the market price.
They can sell nothing above the market price (given that information is perfect buyers can
always find sellers with a lower price). Agricultural products are sold in auction markets –the
price of this output changes every day (prices will be close to the previous days prices but not
the same). Actually this is changing. Now farmers often sell output by contract to be fulfilled
at a future date. The contract may specify that that the farmer will receive $5 for each bushel
of wheat delivered in the fall.
Many, perhaps most goods do not fit the perfect competition model exactly. The prices of
most goods don’t change daily. The costs of changing prices may outweigh the benefits of
changing prices. These sort of costs are called menu costs—restaurants don’t change prices
every day because of the cost of making new menus. While a restaurant might succeed in
attracting some customers away from other restaurants with daily price changes it is unlikely
that it would benefit much over those that changed prices, say, every 3 months. Note that
the costs of printing the menus is small compared to the cost of obtaining the information
about what to print.
One problem with changing costs daily is that people become irritated with price increases.
Which would customers prefer: (a) that you keep prices the same over a three month period
or (b) change them daily in response to supply and demand? Many customers might prefer
the certainty.
Automobile manufacturers are very reluctant to lower prices. If they lower prices then other
manufacturers will lower prices as well. It could be the case that all of them sell about the
same number of cars as before the price decrease. So they end up with about the same
market share at a lower price. There is a tendency in the automobile industry to keep prices
fixed. Even when they lower prices they often refuse to admit that is what they are doing –
they give rebates.
Automobile manufactures usually reduce output before than lowering prices. So in the face
of a decrease in demand they will reduce employment.

3. Efficiency Wage Models
These are sticky real wage models as opposed to the older sticky nominal wage models.
The idea is that employers may find it profitable to pay above market wages in some cases.
The benefits the firm may get are
1. Workers may worker harder because they fear that they will not get a job that pays as
well if they lose their current job (the shirking model).
2. Hiring new workers is expensive. Firms face recruiting and training costs. Even on
the job training costs can be expensive. Many new workers don’t have sufficient skills
to earn their keep until they learn these skills. You can avoid these costs by keeping
existing workers by paying higher than market wages (the turnover model).
3. Happy workers are productive workers. A wage rate higher than the market wage rate
makes them happy (the gift exchange model).
So it may be profitable for some firms or some industries to offer higher than market wages.
Consider an unemployed worker hunting a job. This worker may refuse employment from a
firm offering market wages in hopes of finding one from a firm offering higher than market
wages. This is involuntary unemployment.
Insider—Outsider Models
Insiders are workers with good high paying jobs (typically union jobs). These workers can
negotiate with management through their union and have market power. Many trade unions
ran apprenticeship programs at one time. If you wanted to get the skills necessary to work in
that trade you had to belong to the union. The union could regulate the number of skilled
workers and this would give them market power in determining wages. Insiders could make
it very difficult for outsiders to get the skills necessary to work at a trade. Insiders may also
picket outsiders who try to undercut them by offering to work at a lower wage. Insiders will try
to use market power to increase their wages above the market clearing wage. This will result
in involuntary unemployment (or underemployment) by some outsiders who cannot get
insider jobs.
If aggregate demand falls and insiders refuse to lower their wages some insiders will lose
their jobs (become outsiders). There are now even fewer insiders and these may be able to
command either higher wages. The new outsiders will not be allowed to become insiders
again.
Structural labor market unemployment in Europe.