Wage Rigidity

Definition

Wage rigidity refers to the phenomenon where wages are slow to adjust or resistant to change, even in the face of economic conditions that would typically warrant a change in wages. This concept is particularly relevant in the context of long-term unemployment and its causes.

5 Must Know Facts For Your Next Test

1. Wage rigidity can contribute to persistent unemployment by preventing wages from falling to market-clearing levels during economic downturns.
2. Unions, minimum wage laws, and social norms around fair wages can all contribute to wage rigidity and make wages less responsive to changes in economic conditions.
3. Efficiency wage theory suggests that employers may intentionally set wages above the market-clearing level to attract and retain higher-quality workers, leading to wage rigidity.
4. Nominal wage rigidity is more common than real wage rigidity, as workers are often resistant to outright reductions in their nominal wages, even if it would maintain their real purchasing power.
5. Wage rigidity can lead to a prolonged mismatch between labor supply and demand, resulting in higher structural unemployment.

Review Questions

• Explain how wage rigidity can contribute to changes in unemployment over the long run.
  • Wage rigidity, where wages are slow to adjust to changing economic conditions, can lead to a persistent mismatch between labor supply and demand. During economic downturns, wage rigidity prevents wages from falling to market-clearing levels, leading to higher unemployment as firms are unable to reduce labor costs. Conversely, during periods of economic growth, wage rigidity can prevent wages from rising quickly enough to attract new workers, also contributing to higher unemployment. This mismatch between labor supply and demand caused by wage rigidity can result in higher structural unemployment over the long run.
• Describe the role of efficiency wage theory in understanding wage rigidity.
  • Efficiency wage theory suggests that employers may intentionally pay wages above the market-clearing level in order to attract and retain higher-quality workers, improve morale and productivity, and reduce turnover. This practice can lead to wage rigidity, as employers are reluctant to reduce wages even when economic conditions would warrant it. The desire to maintain a productive and engaged workforce, as well as social norms around fair wages, can make employers unwilling to cut wages, contributing to the phenomenon of wage rigidity and its impact on long-term unemployment.
• Analyze the differences between nominal wage rigidity and real wage rigidity, and explain how they can each influence changes in unemployment over the long run.
  • Nominal wage rigidity refers to the inability or unwillingness of wages to decrease in absolute (dollar) terms, even when economic conditions would suggest a decrease is warranted. Real wage rigidity, on the other hand, refers to the resistance of wages to adjust in real (inflation-adjusted) terms. Nominal wage rigidity is more common, as workers are often resistant to outright reductions in their nominal wages, even if it would maintain their real purchasing power. Both forms of wage rigidity can contribute to persistent unemployment over the long run. Nominal wage rigidity prevents wages from falling to market-clearing levels during economic downturns, while real wage rigidity can lead to a mismatch between labor supply and demand, as wages fail to adjust to changing economic conditions. The combination of these two types of wage rigidity can result in higher structural unemployment that is slow to resolve.

Related terms

Nominal Wage Rigidity: The inability or unwillingness of wages to decrease, even when economic conditions would suggest a decrease is warranted.

Real Wage Rigidity: The inability or unwillingness of real wages (wages adjusted for inflation) to adjust, even when economic conditions would suggest an adjustment is needed.

Efficiency Wage Theory: The idea that employers may pay higher-than-market-clearing wages to increase worker productivity, morale, and retention, leading to wage rigidity.