Real Rigidities in the Labour Market
New Keynesian theories of the labour market help in explaining the existence of involuntary unemployment. The theories also attempt to explain why changes in aggregate demand lead to larger changes in employment and relatively smaller changes in the real wage in the labour market. One of the reasons postulated for the existence of unemployment in the labour market is that firms voluntarily pay higher real wages, as compared to the market-clearing wage, to the workers on their rolls with a view to increasing their efficiency and1 or with a view to providing them the incentives not to shirk work in a situation where the effort level of the workers cannot be perfectly monitored. The imperfections caused thereby in the labour market lead to unemployment. We will qonsider efficiency wage model postulated in New Keynesian theories of unemployment in greater details.