Answer to Question #269743 in Macroeconomics for Maggie

Question

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

Answer 1

• Minimum wage laws- these laws prevent wages from falling to equilibrium levels. Although most workers are paid a wage above the minimum level,for some workers especially the unskilled and inexperienced, the minimum wage raises their wage above the equilibrium level. It therefore reduces the quantity of their labor that firms demand, and an excess supply of workers results i.e. unemployment.
• Monopoly power of unions- this causes wage rigidity because the 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 often raises the wage above the equilibrium level and allows the firm to decide how many workers to employ. These high wages cause firms to hire fewer workers than at the market clearing wage, so wait unemployment increases.
• Efficiency wages- efficiency wage theories suggest that high wages make workers more productive. The influence of wages on worker efficiency may explain why firms do not cut wages despite an excess supply of labor. Even though a wage reduction decreases the firm's wage bill, it may also lower productivity and therefore the firm's profits.