2.3 Real and nominal wages

• Actions of employers (buyers) and employees (sellers) determine wages (prices)

• These prices act as signals or incentives

• Part of the worker's income

Total compensation = wage + fringe benefitsTotal income = total compensation + other income

• Wages (Definition): price of labor services

• Nominal wages, expressed in monetary units

• Real wages, expressed in units of another good

• Prices faced by consumers: CPI (base year = 100)

Real wages (t) = [nominal wage (t) / CPI (t)]

2.3 Real and nominal wages

2.4 The functioning of the labor market

• The LM is one of the three major markets in which firms operate (others: financial and product)

• Demand: decisions in terms of employment will be affected by what happens in other markets

• Supply: decisions about how much to work (or if working or not) should consider time’s alternative uses

• Wage Determination: supply and demand

• Companies combine factors of production to produce goods and services that are sold in the product market

• The output and the combination of factors depend on:– Demand for the product– K & L available– Technology

• Study of labor demand: how a change in these factors affects the amount of employees (or hours worked)

2.4 The functioning of the LM: Demand

Different levels of wages determine different levels of employment graphically: labor demand curve

DL = f (W) labor demanded given the changes in WRelation (slope) NEGATIVE

Changes in W changes upon the curve

Also, changes in other factors / forces that affect DL (DC, PK, Pi, no. of firms, productivity of workers, etc.) shifts of the curve (ceteris paribus)

2.4 The functioning of the LM: Demand

Change in (real) wages: how it affects the no. of employees?

1) If W up costs up PC up DC down YC down DL down

Scale effect: employment effect of a change in the scale of production ... but also ...

2) If W up DK up (with PK fixed) new technology DL down

Substitution effect: employment effect of a change in relative prices

2.4 The functioning of the LM: Demand

What happens now if there is a change in PK : how it affects the no. of employees?

1) If PK down costs down PC down DC up YC up DL up

Scale effect: as before, the employment effect of a change (increase) in the scale of production, and also ...

2) If PK down DK up new technology DL down

Substitution effect: as before, the employment effect of a change in relative prices, but now the effect is opposite to the effect of the scale effect final effect is ambiguous

2.4 The functioning of the LM: Demand