Wage and employment relationship

wage and employment relationship

The Relationship Between Labor Market Conditions and Wage Growth in a tight labor market, workers have more employment options and. Unemployment is a situation where people who are willing to work at or below prevailing wage rates cannot find employment. It is thus natural to begin by asking. relationship between real wage and employment and their effect on relationship from real wages to employment or unemployment levels with wages.

The Relationship between Wage Cut and Employment (With Diagram)

Unemployment in some states reached almost 15 percent, while in others it remained around 4 percent during the worst of the recession.

Given this disparity, wage pressures can be expected to evolve differently in different areas. An examination of wage growth and unemployment data on a subnational level reveals interesting variation and helps identify a Phillips curve relationship even for short periods of time. The left panel of the figure plots the Phillips curve for the 50 states from to Each point represents a year-state combination, with the year-over-year growth in nominal earnings on the y-axis and the yearly unemployment rate on the x-axis.

For example, green diamonds are used for both and As the data show, the negative relationship between unemployment and earnings growth seems to hold across states. Economic research suggests that not all wages react the same way to economic conditions and wages of new hires may be more sensitive to the state of the labor market. The intuition is that, in a tight labor market, workers have more employment options and firms desiring quality workers must offer high wages.

wage and employment relationship

The right panel of the figure includes earnings of new hires only rather than all employees. Both panels suggest that wages tend to respond to conditions in the labor market and to the unemployment rate in particular.

wage and employment relationship

Since labor markets in the United States have substantially improved and are expected to improve even more, it is likely that nominal wages will increase at a faster pace. Suppose cut in wage rate is made which lowers marginal cost. This increase in output will depend on the elasticity of demand curve of output; the higher the demand elasticity, the greater the expansion in output.

This expansion in output will lead to the increase in demand for or employment of labour.

Similarly, on the basis of partial equilibrium analysis of the impact of wage cut on price, output and employment in an industry the classical economists applied this result to the impact of all-round cut in wages on the increase in output and employment of labour in the economy. Keynes challenged the classical viewpoint regarding the impact of all-round cut in money wage on output and employment of labour.

The Relationship between Wage Cut and Employment (With Diagram)

According to him, while in case of the analysis of price and output determination of an individual industry, it is justified to assume that a cut in wages by the industry would not significantly affect the demand for the product of that industry because most of the demand for the product of that industry comes from the workers and persons employed in other industries.

However, to assume that demand curve for output of all industries will remain unchanged when cut in wages in all industries together is made is not valid.

In other words, to apply the result of partial equilibrium analysis of the determination of price, output and employment to the economy as a whole is quit misleading and invalid. This is because wages are not only costs from the view point of individual industries they constitute incomes of the workers and these incomes determine the demand for the products of various industries.

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When all-round cut in wages is made in all industries, it will reduce the aggregate demand for the products because workers would have no less income and therefore would spend less on goods and services. With reduced demand for the products of industries smaller output will be produced.

wage and employment relationship

Therefore, smaller amount of labour will be demanded and employed. It is thus quite clear that a general cut in wages will merely cause a reduction and will not in itself remove unemployment.


The effect of all-around reduction in wages on aggregate output is illustrated in Fig. LAS is the long-run aggregate supply curve at full-employment level of output or national income. According to classical viewpoint, the sufficient cut in wages will cause a downward shift in aggregate supply curve, say to the new position SAS1 with the result that new equilibrium is established at full employment output YF.

wage and employment relationship

But, according to Keynes, all-round cut in wages will reduce incomes of the workers and therefore expenditure made by workers which will cause a leftward shift in the aggregate demand curve AD, say to the new position AD1.

If the decrease in aggregate demand is proportional to the increase in aggregate supply, then equilibrium might be reached at the original aggregate output Yo.

wage and employment relationship

Consequently, level of employment will remain below the full-employment level.