12.2 – A Review of the Orthodox Wage and Price Adjustment Story
12.2 – A Review of the Orthodox Wage and Price Adjustment Story
Learning Objectives
By the end of this section, you will be able to:
- Explain the primary components of orthodox macroeconomics
- The significance of price and wage adjustments within the orthodox paradigm
- The inherent laissez-faire aspects of the orthodox argument
Generally, for most contemporary orthodox economists (neoclassical school, New Keynesian, et al.) the macroeconomic purpose of price adjustments can be likened to releasing a marble down the side of a large bowl, eventually after making several passes, moving up and down along the sides, the marble will come to rest at the bottom of the bowl. In this analogy the bowl represents the economy, the marble represents prices, and the marble coming to rest represents equilibrium. In practice this means that if demand were to decline, then at existing prices there will be a surplus of (unsold) products in the economy. In the case of a surplus, price deflation becomes the market adjustment needed to correct for the disequilibrium, restoring equilibrium as well as economic stability.
Orthodox economics argues that wage and price flexibility represents the normal condition of markets and the macroeconomy in general, allowing the economy to consistently operate at its greatest potential. In Chapter X, the “Introduction to the Orthodox Perspective,” the neoclassical economic foundations of the orthodox viewpoint regarding the importance of flexible wages and prices is neatly summarized.
“The classical view, the predominant economic philosophy until the Great Depression, was that short-term fluctuations in economic activity would rather quickly, with flexible prices, adjust back to full employment.”
In other words, “optimal” economic conditions are assured by wage and price flexibility.
For clarification purposes, it’s worthwhile to take a closer look at the mechanics of the orthodox position. Orthodox economics emphasizes that in a market system characterized by wage and price flexibility, any market experiencing disequilibrium will quickly return to equilibrium as wages and prices adjust (upward or downward), as necessary, to eliminate market surpluses and/or shortages. The result is an economy in which all markets, product (goods and services) and resource (labor, etc.), gravitate toward equilibrium. By continuation, if all markets gravitate toward equilibrium, then it is the tendency of the economy to have a fully employed labor market because equilibrium means that labor supply equals labor demand. General equilibrium will also mean that the economy will also produce and sell the full employment level of products.
If wage and price flexibility tends to generate ideal economic conditions, then it also stands to reason that the opposite, wage and price stickiness, will be responsible for “sub-optimal” economic outcomes. Assuming that the economy is destabilized by any unforeseen factor(s), while wage and price flexibility will ret