Aggregate demand is the quantity of all goods demanded in the economy.

1. Aggregate demand drops. This shifts the curve to the left. These leads to a drop in the price and quantity of goods exchanged in the economy.

2. If firms are producing less goods they need less workers to produce these goods.

3. If they need less workers, the demand for workers shifts to the left.

4. This means the price and quantity of workers drops(wage cuts and increased unemployment)

Price and wage stickiness is one tool that New Keynesian economists use to try to explain business cycles using microfoundations.

Keynesians don't need it they use other routes to explain why aggregate demand exists(Pigou's wealth effect, Keynes interest rate effect, and the Mundell-Fleming exchange-rate effect). The downside to the Keynesian approach is the Lucas critique[0]. That relationships based on historical data are vulnerable to change when monetary policy changes. This started the New Keynesian/NeoClassical/Keynesian dvision.

[0] - https://en.wikipedia.org/wiki/Lucas_critique

Aggregate demand is not a quantity, it's a relationship between output and price level. But anyway, following your story, you get reduced employment.

But you don't get involuntary unemployment - people employed at a price $P as well as people unemployed but willing to accept work at the same price. All your story gives us is that there is a new market clearing price for labor at a lower price level, e.g. $P2 < $P. Fewer people are willing to accept labor at $P2, so they voluntarily go without work.

This is pretty much just basic supply&demand. You don't even need to go as far as Keynesian theory to get this out. If this is Varoufakis' story, it's hardly clear why he is criticizing classical econ 101 at all.

You're right that if we shift the aggregate demand curve its all econ 101 from there to wage and employment drop.

The difference between schools is that even though Keynesians believe in an aggregate demand curve( a relationship between price level and output) the neoclassicals(i.e. Chicago school) do not.

Varoufakis is criticizing the neoclassicals because they don't believe in an aggregate demand curve. Instead all of their modelling is done on the supply side. And its very hard to tell a supply side story where both employment and wages fall.

Involuntary unemployment is an easy jump from falling wages and employment.

It's not very hard to tell a "supply side" story where employment and wages fall at all. Just repeat your supply & demand example but substitute a specific good for aggregate demand. Or assume a decrease in the demand for labor due to automation, a reduction in labor hoarding, better ability to sort employees by productivity, etc.

Also, Varoufakis is criticizing "macroeconomic models taught at the best universities". Keynesian economics has been taught at universities for nearly 100 years.

I'm not quite sure how any of those supply side effects could cause unemployment or wage changes on the scale of what is happening in Greece. But if you could explain how those effects could have led to the unemployment and wage drops we've seen in Greece I would love to learn.

It seems to me there are two possibilities.

1. When Varoufakis talks about macroeconomic models taught at the best universities feature no accumulated debt, no involuntary unemployment and, indeed, no money (with relative prices reflecting a form of barter) he is talking about Keynesian.

Keynesian theory includes involuntary unemployment, accumulated debt, and money. So Varoufakis would have to have been mistaken. And he is shown to be especially confused when he later remarks

Moving to the micro level, the observation that, in the case of Greece, real wages fell by 40% but employment dropped precipitously, while exports remained flat, illustrates in Technicolor how useless a microeconomics approach bereft of macro foundations truly is.

This means he believes Keynesians are especially focused on microfoundations and ignore macro foundations. When this is actually true of the Neoclassical school. Then there is the issue you brought up. Varoufakis critiques Keynesians at the beginning and then appeals to it at the end. This implies he does not understand the basics of Keynesian theory. This is very surprising because he thinks of Keynes as one of the economists that personally influenced him the most.

2. Varoufakis is actually talking about Neoclassical economics.

This makes a lot of sense. Many Neoclassical economic models lack money, don't have involuntary unemployment, and lack accumulated debt. In addition it is very hard to tell a story about large wage drops, and growth in unemployment from microfoundations(basically supply-side). This means he is being consistent when he later appeals to Keynesian economics.

Varoufakis is obviously a very intelligent man who has spent 28 years studying economics. I would be incredibly surprised if he was confused about the basics of the two most influential schools of thought in macroeconomics.

>Also, Varoufakis is criticizing "macroeconomic models taught at the best universities". Keynesian economics has been taught at universities for nearly 100 years.

That still doesn't make the models he was actually describing any more Keynesian.

It it taught, although it has fallen out of favor somewhat. The preferred school for teaching these days is neoclassical, which is the school he was criticizing.

Keynesian != Neoclassical

Just in case you didn't get it the other 11 times, he wasn't talking about Keynesian economics.

Step 2 is:

* Austerity slashes public sector worker pay and pushes public sector workers into unemployment.

* Since public sector and private sector workers compete in the same job market, reducing the wages of one reduces the wages of the other through increased competition.

* Since the public sector is the largest single customer of the private sector, reducing its spending reduces the income of the private sector. This leads to lay offs and retrenchments in pay as well.

* Increasing unemployment also puts downward pressure on wages. The more desperate people are to have a job, the lower the wages they will accept.

* More downward pressure is put on wages by slashing social security, too (usually austerian target #1). The more unpleasant you make unemployment, the more desperate people will be to take a job. The more desperate people are to take a job, the lower the wages they accept will be.

This is a purely classical (pre-keynesian) story - demand goes down in many individual markets, and the market adjusts by reducing prices and quantity supplied. It has no output gap, no involuntary unemployment (read: wages at a price $P, but people willing to work at $P and unable to find a job), etc.

You've just shown that classical economics explains the Greek situation perfectly, contradicting Varoufakis.

No, neoclassical economics would have us believe that wages would go down until a clearing price was hit and everybody was employed.

This is, indeed, exactly the type of mind numbing idiocy that Varoufakis was talking about.

That's exactly what happens in your story. Wages go down from $P to $P2. Fewer people are willing to work at $P2 than at $P, so employment goes down. That's a standard market clearing story.

The classical claim is that don't have involuntary unemployment - prevailing wage levels equal to $P (in some segment) and simultaneously people unable to find work at $P.

Your story agrees with this.