5.3 Using the Aggregate-SupplyAggregate-Demand Diagram

with full employment, so in the face of deficient demand they do not press workers for lower wages. There are several reasons for this policy:
a. By paying an abnormally high real wage a firm may be able to hire a better quality of worker.
b. Workers may react by putting forth more work effort, either because they feel morally bound to do so or because they could be fired from an attractive insider job if they are caught shirking.
c. The high wage should reduce labor turnover, lowering hiring and training costs. The classic example of such behavior is Henry Ford's 1914 successful offer of $5 per day, a huge jump in the going wage.
All this suggests that a negative demand shock will most likely move the economy to point DD in figure 5.4 where the goods-and-services market is in equilibrium but the labor market is not. If the unemployed workers do not cause wages to fall, no forces are set in motion to push the economy back to full employment. Keynes explained this result simply by stating that the unemployed do not bid down wages, so the economy is stuck at point DD, sometimes called a less-than-full-employment equilibrium. Modern interpreters draw the same conclusion but provide reasons why economic agents act in rational, maximizing ways to cause wages to be sticky. This approach has earned them the name New Keynesians.
The upshot of all this is that although the economic forces of supply and demand may eventually operate to bring an economy out of recession and back to full employment, they
Curiosity 5.2: Are Real Wages Countercyclical?
Some economists have claimed that the theoretical arguments of this chapter can be checked by seeing whether real wages are countercyclical: do they rise during recessions and fall during booms? A key ingredient of this theory is that a fall in real wages induced firms to hire more labor, decreasing unemployment, increasing output, and pushing the economy into the expansionary phase of the business cycle, suggesting that real wages must be countercyclical. This sequence of events does not necessarily happen, however. Other arguments have suggested that firms are primarily quantity adjusters, increasing output by means of overtime as the economy goes into a boom, and decreasing output through labor hoarding and layoffs as the economy enters a recession. Price reactions take place only after the boom or recession has continued for some time, with price changes preceding, matching, or following wage changes, depending on circumstances. Firms in perfectly competitive industries, for example, are likely to have price changes precede wage changes; firms in imperfectly competitive industries may follow a markup pricing strategy and so may not increase prices until wages increase. Furthermore, cyclical movements initiated by aggregate demand shocks will have different characteristics from movements initiated by supply-side shocks, so there is no guarantee that real wages are countercyclical. The emprical evidence suggests that they follow no consistent pattern over the cycle.

 



Macroeconomic Essentials. Understanding Economics in the News 2000
Macroeconomic Essentials - 2nd Edition: Understanding Economics in the News
ISBN: 0262611503
EAN: 2147483647
Year: 2004
Pages: 152

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