New classical economics builds on neoclassical ideas and strives to explain how fluctuations in employment and real wages are caused by technological changes and by willingness to work. A distinguishing theory of new classical economics is that wages and prices are immediate and flexible. When the marginal product of labour is affected by technological changes, it will lead to changes in the demand for labour. This will lead to shifts in employment level and wages¹. Changes in willingness to work will cause changes in the labour supply and therefore shifts in the level of employment and wages.
New classical economists will assume that, in business cycles, short-run fluctuations in real GDP are the result of fluctuations in potential output. Therefore, unemployment is equal to the non-accelerating inflation rate of unemployment (NAIRU) and it is the NAIRU that fluctuates¹. Fluctuations in cyclical unemployment are caused by supply shocks from sources like oil price changes and changes in taste.
New classical theory assumes that labour markets are always clear. When people are not working, they are assumed to have voluntarily withdrawn from the labour market. This means that there is no involuntary unemployment.
New classical theory has been supported by the claims that an economy affected by technological shocks and changes in taste shows similar fluctuations to those of a real economy¹. The ideas also show how shocks can spread to different sectors of the economy over time.
1. Ragan, Chrisopher. Macroeconomics/Christopher T.S. Ragan, Richard G. Lipsey. – 13th Canadian ed.