uses a great deal of social distress and concern; as a result, the causes and consequences of unemployment have received the most attention in macroeconomic theory. Until the publication in 1936 of The General Theory of Employment, Interest and Money by Keynes, large-scale unemployment was generally explained in terms of rigidity in the labor market that prevented wages from falling to a level at which the labor market would be in equilibrium. Equilibrium would be reached when pressure from members of the labor force seeking work had bid down the wage to the point where either some dropped out of the labor market (the supply of labor fell) or firms became willing to take on more labor given that the lower wage increased the profitability of hiring more workers (demand increased). If, however, some rigidity prevented wages from falling to the point where supply and demand for labor were at equilibrium, then unemployment could persist. Such an obstacle could be, for example, trade union action to maintain minimum wages or minimum-wage legislation.Keynes's major innovation was to argue that persistent unemployment might be caused by a deficiency in demand for production or services, rather than by a disequilibrium in the labor market. Such a deficiency of demand could be explained by a failure of planned (intended) investment to match planned (intended) savings. Savings constitute a leakage in the circular flow by which the incomes earned in the course of producing goods or services are transferred back into demand for other goods and services. A leakage in the circular flow of incomes would tend to reduce the level of total demand. "Real" investment, known as capital formation (the production of machines, factories, housing, and so on), has the opposite effect-it is an injection into the circular flow relating income to output-and tends to raise the level of demand.In the earlier classical models of unemployment, such as the one described...
