The employment real wage relationship

Money Wage, Real Wage and Employment (Fundamental Relations)

the employment real wage relationship

Investigates the long‐run relationship between real wages and employment by conducting more reliable tests in the context of 12 European countries, namely. I. Introduction. The neoclassical and Keynesian theories of employment both predict an inverse relationship between employment and real wages in the. Aug 28, There has been a long debate regarding the relationship between real wages and the employment (output). Despite the apparent simplicity, the.

To think about this question we must think in terms of an aggregate demand and aggregate supply of labourthat is, in terms of the demand and supply of labour in the economy as a whole. This is modeled in Figure 3 where we put the real wage ratethat is, the nominal wage rate divided by the price levelon the vertical axis. The aggregate demand for labour will be negatively related to the real wage rate for the same reason that the demand curve for labour in any industry is negatively slopedat lower wages firms will substitute the less expensive labour for capital and their costs will be lower so they can produce and sell more output.

The aggregate supply curve for labour, however, may not be positively sloped throughout its range. The reason is the wealth effect of increased wages. At low wage levels, higher wages induce people to work more because they make leisure more costly in terms of the income that must be given up at the margin to obtain it.

the employment real wage relationship

Workers substitute income for leisure. At higher wage and income levels, however, the increase in income that can be obtained by working more in response to a higher wage typically becomes less valuable than the leisure that is foregone.

the employment real wage relationship

A wage level will be reached beyond which workers will do less work for higher wages because they can maintain the same satisfaction as before, or even increase it, with less work effort.

As people become wealthier they take more leisure and do less work. Thus, an increase in wages beyond some level, by further raising wealth, increases desired leisure by more than increased opportunity cost of leisure reduces it. The wealth effect of higher wages on leisure offsets the substitution effect. This explains why the enormous growth of per capita income in western countries during the last century has been accompanied by substantial declines in hours worked per week.

Figure 3 shows clearly the effect of an institutionally fixed minimum wage, whether imposed by the government or by union power, on aggregate employment in the economy.

Wage Rates and the Supply and Demand for Labour

Unlike the case where wages are fixed in some sector of the economy, the labour displaced here by the minimum wage has nowhere to go to bid down wages to obtain employment. Industrialized economies like those of Canada and the United States are less than one-third unionized. Minimum wages are in force but they are quite low and would displace only the most unskilled workers from employment. Why then do we observe substantial unemployment in these economies from time to time? What is it that is keeping wages too high, and preventing workers from bidding them down?

This is the subject of our next three Topics.

Money Wage, Real Wage and Employment (Fundamental Relations)

Before addressing it, however, there are two preliminary issues that must be dealt with. First, we must recognize that even under the best conditions there will always be some amount of unemployment. Some people will be in the process of moving between jobs.

Technological change inevitably leads to job losses in some areas of the economy and new jobs in other areas. It takes time for those displaced to relocate.

Some degree of unemployment in the economy is thus inevitable and is not a signal that people who want jobs at current wages cannot find them.

The normal level of this frictional unemployment is termed the natural rate of unemployment. Frictional unemployment does not appear in Figure 3. Workers in the process of becoming informed are not part of the analysis.

the employment real wage relationship

The fact that frictional unemployment does not appear in Figure 3 and play a role in the determination of the equilibrium wage rate in the economy highlights the second issue that we must address. In other words, individual buyers and sellers have no influence on the market price. Market prices are determined by all buyers and sellers together. But this raises a fundamental question.

The Employment-Real Wage Relationship: An International Study

A firm in a competitive industry will hire workers upto the point where the value of marginal product marginal product multiplied by the price of output just equals the cost of the factor.

Assuming that the pure competition prevails, the profit maximization condition of the economy as a whole may be written as: The demand for labour, therefore, may be written as: According to the law of Diminishing Marginal Returns, the marginal product of labour declines as more workers are hired.

the employment real wage relationship

It follows that if the level of employment is to be increased, the real wage must fall. The demand for labour is, therefore, a decreasing function of the real wage rate. Consequently, the classical labour supply function may be written as: Anybody unwilling to work at that wage rate is, therefore, considered as voluntarily unemployed. Hence, on the basis of above definitions, relations and assumptions, the theorem are advanced that unemployment is considered incompatible with equilibrium.

Such is the self-adjusting classified system of automatic full employment equilibrium.

the employment real wage relationship

It is therefore, clear that during the pre-Keynesian era when classical theories held away, employment problem was never taken so seriously. The state of full employment was considered as a normal feature of the economy, and lapse from it being taken as frictional, temporary, and originating from the imperfections of the market.