Aggregate Demand and Keynesian Unemployment

Abstract

This chapter argues that in a growing economy unemployment can be the cause of goods markets failures, even if these are purely transitory. As the economy grows, new firms wish to enter product markets. It may take some time, however, for their products to be accepted in the market, a phenomenon which we model as a purely transitory demand shock. Firms who fail early entry will renege on any job offers, causing unemployment. Anticipating this, workers will ask for a risk premium in insecure contracts, distorting the price and supply decisions of firms, and reducing incentives to invest into novel products. This will reduce, but will not eliminate the number of precarious job offers. Thus, a transitory demand shock will lead to a persistent level of unemployment in a growing economy.