Sticky Wage Theory
Candlefocus EditorAlthough there are many possible explanations as to why wages are slow to adjust, the main argument is that this occurs because wages are determined by prior agreements and expectations between employers and employees about the employee's real wage. Thus, an employer may be compelled to honor these expectations, at the risk of alienating workers, even if it means profitability is diminished in the short-term. For example, an employer's refusal to cut wages could lead to lay-offs or other forms of cost cutting.
Inflation also plays a role in sticky wages. Since wages are often determined on a nominal basis, rather than a real basis, workers often experience an erosion of their wages over time due to inflation. This is because wages in nominal terms may remain the same, even though their real value - the purchasing power of wages - has been reduced.
As with any theory, there are counter-arguments. For instance, if employers can increase wages easily during periods of high economic activity, why can they not reduce wages just as easily during troubled economic times? However, despite some criticism, sticky wage theory remains a fundamental concept of Keynesian economics.
Today, the theory of sticky wages has applications in many areas of economics. For example, economists examining pricing in labor markets often use the sticky wage theory to explain why wages in a particular sector or region don't always adjust quickly to reflect market conditions. Additionally, the theory is often used to explain why certain prices and taxation levels remain stable over time. For instance, as workers would typically oppose pay cuts, governments may be compelled to not make cuts to certain social welfare programs or services, leading to their relative stability over time.
In summary, the Sticky Wage Theory is an essential concept in Keynesian economics which proposes that wages, prices, and taxes tend to be slow to adjust to changing economic conditions. As downward wage adjustments are often disadvantaged by workers, firms are provided with incentives to take cost reductions in other forms- leading to potential lay-offs or cutting back on hours. Additionally, because wages can often be determined nominally, workers may experience an erosion of their real wages due to inflation. It is also important to note that the sticky wage theory has applications in many areas of economics, from pricing in labor markets, to the stability of certain prices and taxes over time. Despite some criticism, sticky wages remain an essential concept in economics and have many practical implications in today's society.