Final answer:
Classical economics assumed that wages were flexible and would adjust during a recession. Modern theories propose that wages are sticky, leading to cyclical unemployment. Keynesian economics further explains the difficulty of implementing wage reductions in a market economy.
Step-by-step explanation:
The statement that a key assumption of classical economics was that wages were flexible and would fall during a recession is true. Classical economists believed in a self-correcting economy where prices and wages would adjust to ensure that supply and demand remained in equilibrium.
During a recession, they assumed that wages would decrease to match the lower demand for labor, preventing prolonged periods of unemployment.However, modern economic theories suggest that wages are often sticky, meaning they do not adjust downwards easily during economic downturns.
Several reasons have been proposed for this stickiness, including implicit contracts, efficiency wage theory, adverse selection with wage cuts, the insider-outsider model, and relative wage coordination. These theories imply that wages tend to decline very slowly if at all, which can lead to cyclical unemployment in both the short and long run.
Keynesian economics expanded on this idea of wage stickiness and introduced the concept of coordinated wage reductions being hard to implement in a market economy. This stubbornness of wages to fall in the face of declining labor demand can cause unemployment levels to rise, as shown in various economic models and figur