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Why is full employment desired in an economy if competition promotes innovation?

In the simple Keynesian model, full employment equilibrium is a desired outcome, as everyone is employed.

However, if people are in fear of being replaced by someone better than them, they will automatically work harder to innovate, so that they will be indispensable to their employer.

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    $\begingroup$ In the basic models, innovation is exogenous. So they don't have this channel. But, in practice, innovation is endogenous. But you don't need unemployment to get incentive alignment, and in any case the sort of people who do most of the innovation (say college educated people in their peak working years), have very very low unemployment. $\endgroup$
    – BKay
    Feb 10, 2023 at 18:47
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    $\begingroup$ If companies have to compete for employees, does that not foster innovation? How come workers' fear is beneficial but companies' isn't? $\endgroup$
    – Giskard
    Feb 10, 2023 at 23:28

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Your question shows quite a lot of misunderstanding about what full employment means so let me first correct this.

Full employment does not mean everyone is employed. Even at full employment there will be quite large number of unemployed people. Full employment refers to situation where labor market is in equilibrium and where everyone people who want to work at prevailing wage can find work. Even when economy is at full employment there will be some people that are unemployed because they do not think the market wage is enough to compensate them for opportunity cost of their free time, or there might be a frictional unemployment that occurs when people are between jobs. In practical terms this is usually measured by NAIRU (Non-Accelerating Inflation Rate of Unemployment), that is unemployment at which the inflation is not accelerating (see BLS explainer).

Now that we properly defined full employment we can discuss why it is considered by many desirable.

The reason why full employment is considered desirable is that when there is full employment, economy works at its full potential. Every economy is constrained by its production possibilities frontier (PPF) which tells us how much can at a given point in time, given its technology and resources, produce. When economy does have full employment we are producing somewhere at the PPF (or near to given that in practice it is difficult to measure what NAIRU is). When there isn't full employment we are producing somewhere within our PPF. That is considered to be quite undesirable because that means we could, with our resources, provide more goods and services (more or better food, more healthcare, more education etc) to the people if we would increase the level of employment up to full employment. As mentioned, even at this full employment there will be unemployed people, but going beyond the point of full employment would mean resources are unsustainably overutilized (e.g. people employed at positions where they create less value than their wage, or too much overworking of previously employed workers etc).

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