Answer to Question #251814 in Macroeconomics for Sany

Question

Give three explanations why the real wage may remain above the level that equilibrates labor supply and labor
demand?

Answer 1

Solution:

The real wage may remain above the level that equilibrates labor supply and labor demand because of minimum wage laws, the monopoly power of unions, and efficiency wages.

 

1.). Minimum wage laws - Wage rigidity is caused by minimum-wage laws that prevent wages from falling to equilibrium levels. Although most workers are paid more than the minimum wage, the minimum wage raises the wage of some workers, particularly the unskilled and inexperienced, above the equilibrium level. As a result, it reduces the quantity of labor that firms require, resulting in an excess supply of workers, i.e., unemployment.

 

2.). The monopoly power of unions - Wage rigidity is caused by unions' monopoly power because wages of unionized workers are determined not by the equilibrium of supply and demand, but by collective bargaining between union leaders and firm management. The wage agreement frequently raises the wage above the equilibrium level and allows the firm to choose how many workers to hire. As a result of these high wages, firms hire fewer workers than they would at the market-clearing wage, and wait for unemployment rises.

 

3.). Efficiency wages - According to efficiency-wage theories, higher wages make workers more productive. The impact of wages on worker efficiency may explain why firms do not cut wages despite a surplus of labor. Even though a wage cut reduces the firm's wage bill, it may also reduce worker productivity and thus the firm's profits.