Figure 1 shows how national income is produced. Capital and labour combine in a production function and give national income. Capital is aggregated in dollars, labour in personyears. [ [29]
Let labour supply be LS and the unemployment rate be u. In the unemployment regime 0 only LS (1 - u) work, producing a national income of Y0 in wages and profits. The slope of the tangent gives the price ratio of wages and rents. In regime 1 LS work, producing Y1. The rise of national income from regime 0 to 1 is the increase in efficiency from going from the lower to the higher isoquant. The graph clarifies about the improvement in efficiency that: (a) more people work, (b) total income is higher, (c) average wage costs are lower, indicating lower pressure on prices, (d) hence, when there is unemployment, then there is a possible improvement, that benefits some while it needn’t hurt others.
The story of course doesn’t stop with Figure 1, and is a bit more difficult. Some points need to be developed - just indicative, not extensive:
1. We have to show that (current) unemployment is inefficient indeed, and that it is not caused by technology or globalisation or labour market inflexibility (which would cause it to be a form of efficient unemployment).
2. Wages may fall on average, but the story for each individual is different. We have to deal with heterogeneous labour. And we have to develop the impact on inflation.
3. An econometric problem is that observations are based on observations of LS (1 - u), i.e. on the inefficient area, so that extrapolations towards the true efficiency frontier are difficult, especially when labour is heterogenous.
4. Policy makers tend to see the decision process as a clash of preferences. When a tax reduction is proposed, to tackle unemployment, then this is translated in their minds into terms of the (re-) distribution of income - and then it is quickly opposed. So we have to deal with this source of misunderstanding too.
5. Though above uses a Bergson-Samuelson social welfare function, many economists are hesitant about that approach and refer to Arrow’s theorem. This matter then needs clarification too.
