Sticky Wages

Definition

Sticky wages refer to the phenomenon where wages in the labor market are slow to adjust to changes in economic conditions, remaining relatively fixed or 'sticky' even when supply and demand would suggest they should change. This concept is crucial in understanding the causes of changes in unemployment over the short run, the Keynesian perspective on market forces, and the balance between Keynesian and neoclassical models.

5 Must Know Facts For Your Next Test

1. Sticky wages are a key component of Keynesian economics, as they help explain why markets may not automatically clear and why unemployment can persist in the short run.
2. Nominal wage stickiness, where wages fail to adjust for changes in the price level, can lead to fluctuations in real wages and affect the labor market equilibrium.
3. Efficiency wage theory suggests that employers may intentionally pay higher-than-market wages to improve worker productivity and retention, contributing to sticky wages.
4. Sticky wages can lead to a surplus of labor, as the quantity of labor supplied exceeds the quantity demanded at the prevailing wage rate, resulting in unemployment.
5. The concept of sticky wages is crucial in the Keynesian model of aggregate demand and aggregate supply, where it helps explain why the aggregate supply curve may be upward-sloping in the short run.

Review Questions

• Explain how the concept of sticky wages relates to changes in unemployment over the short run.
  • Sticky wages, where wages are slow to adjust to changes in economic conditions, can lead to a surplus of labor and persistent unemployment in the short run. When demand for labor decreases, wages may not fall quickly enough to clear the labor market, resulting in a situation where the quantity of labor supplied exceeds the quantity demanded at the prevailing wage rate. This mismatch between supply and demand leads to unemployment, as employers are unwilling to hire additional workers at the higher-than-equilibrium wage level.
• Describe the role of sticky wages in the Keynesian model of aggregate demand and aggregate supply.
  • In the Keynesian model, sticky wages are a key factor that contributes to the upward-sloping aggregate supply curve in the short run. When there is an increase in aggregate demand, firms may initially respond by increasing output rather than raising prices, as wages are slow to adjust upward. This is because employers are hesitant to raise wages, fearing that they will not be able to lower them again if demand falls. Over time, as wages and prices adjust, the aggregate supply curve becomes more vertical, reflecting the long-run relationship between output and the price level.
• Analyze how the concept of sticky wages helps balance the Keynesian and neoclassical perspectives on market forces.
  • The concept of sticky wages helps reconcile the Keynesian and neoclassical views on market forces. Neoclassical theory assumes that markets, including the labor market, will automatically clear, and any unemployment is voluntary. In contrast, Keynesian economics recognizes that wages and prices may not adjust quickly enough to maintain full employment, leading to persistent unemployment. Sticky wages provide a bridge between these two perspectives, as they explain why the labor market may not clear in the short run, even though neoclassical theory suggests it should. This balance between Keynesian and neoclassical models is crucial for understanding the complex dynamics of the economy and the role of government intervention in stabilizing economic fluctuations.

Related terms

Wage Rigidity: The inability or unwillingness of wages to adjust downward in response to a decrease in labor demand, leading to a surplus of labor.

Nominal Wage Stickiness: The tendency for nominal (money) wages to remain unchanged despite changes in the price level, resulting in fluctuations in real (inflation-adjusted) wages.

Efficiency Wage Theory: The idea that employers may pay wages above the market-clearing level to increase worker productivity, motivation, and loyalty, leading to persistent unemployment.