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Economic Theory
At a higher real wage, firms demand fewer labor hours. A higher real
wage means that labor time is more expensive than before, so each
individual firm demands less labor and produces less output. The point
where the labor supply and demand curves meet is the equilibrium in the
labor market. At the equilibrium real wage, the number of hours that
workers choose to work exactly matches the number of hours that firms
choose to hire.
The total amount of money received by the laborer in the process of
production is called nominal wage. Nominal wages do not depend on costs
in the economy and require no calculation. Remember that the real wage is
calculated as follows:
. (4.3)
Real wages are the amount of income a person earns relative to some
past date while correcting for the impact of inflation. Real wages provide
insight into the actual purchasing power a worker has. Real wages only
increase if nominal wages increase faster than the inflation rate. If prices
increase faster than nominal wages, real wages will fall. The real wage is
defined as the nominal wage divided by the general price level.
The government causes wage rigidity when it prevents wages from
falling to equilibrium levels. Minimum-wage laws set a legal minimum on
the wages that firms pay their employees, it is named minimum nominal
wage. Even if the nominal wage is fixed, the real wage decreases when the
price level increases. It follows that rigidities in the nominal wage translate
into rigidities in the real wage only if the price level is also sticky.
Another story goes by the name of efficiency wages. Wages in excess
of the equilibrium real wage that are paid by firms to provide incentives
for their workers to perform their duties. The idea here is that firms have
an incentive to pay a wage above the equilibrium. Workers who are paid
higher wages may feel better about their jobs and be more motivated to
work hard. Firms may also find it easier to recruit good workers when they
pay well and find it easier to keep the workers that they already have. The
extra productivity and lower hiring and firing costs may more than
compensate the firm for the higher wage that it is paying.
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