Price-Wage Rigidity, Essay Example

Wage rigidity mainly refers to the challenges that global firms faced in the process of reducing their employees’ wages especially due to labor policies and other productivity based reasons (Kaufman 501).  In most cases, global firms usually employ the use of layoffs in order to control and prevent lower profits and losses in the firm (Kates 316). According to classical economist beliefs, it is evident that prices and quantities of products and services usually adjust to the changes in the forces of supply and demand (Economist’s View 5).   Furthermore, classical economists also argue that the economy mostly produces its potential output due to changes in the forces of supply and demand (Economist’s View 3).  However, according Keynesian economists price and wage rigidities usually results in low economy output in the global firms (Kates 323).   Therefore, this paper will evaluate and describe price-wage rigidity systems as well as assess the Keynes view that wage-price rigidity mostly requires government involvement in the market.

Price-Wage Rigidity and Keynesian theory

According to Keynesian theory, price-wage rigidity mostly has an impact on the general economy output due to prices stickiness and changes in demand and supply (Tsoukis, George and Joseph 737). In most cases, global firms usually find it difficult to change their prices and wages to the firm. Furthermore, Keynesian theory outlines and provides a number of factors that usually results into global price stickiness including cost-based pricing, coordination failure, nominal contracts, as well as menu costs and non-price competition (Kates 313). The link between quality and price, implicit contracts and pricing threshold also form some of the factors that result in global price rigidity according to Keynesian model. This is mainly because the global firms usually set their prices in order to promote their market share and profitability.

In addition, short-term changes in demand usually do not affect the prices of goods and services thus firm prices should be based on the firm profitability margin (Kates 318).  Therefore, according to Keynesian theory price-wage rigidity results to poor economic output and unemployment problems thus need for government involvement in the markets. This is because price-wage rigidities are mainly due to minimum wages and can be corrected by the provision of the stable labor force by government agencies (Tsoukis, George and Joseph 738).

In that sense, I fully agree with Keynes assessment that wage-price rigidity requires government involvement in the market in order to create employment equilibrium, as well as stable wages and prices in the market. This will also promote the provision of the stable labor force in the market. I also believe that the provision of flexible prices and wages cannot promote maximum employees output in the firm.  Price stickiness in the firm are also mainly due to monopolistic competition in firms, and this can only be controlled through government involvement in the market (Tsoukis, George and Joseph 741). Furthermore, reduction of taxes and increased government purchases can also stabilize the economy (Tsoukis, George and Joseph 746).  This can also provide effective labor market, proper monetary policies and reduce inflation rates in the market.

Works Cited

Economist’s View. “Price Rigidity” (2008): 2-5. Retrieved from http://economistsview.typepad.com/economistsview/2008/03/the-evidence-on.html

Kates, Steven. “Why Keynesian Concepts Cannot Be Used To Explain Pre-Keynesian Economic Thought: A Reader’s Guide To Classical Economic Theory.” Quarterly Journal of Austrian Economics 17.3 (2014): 313-326.

Kaufman, Bruce E. “Wage Theory, New Deal Labor Policy, and the Great Depression: Were Government and Unions to Blame?” Industrial & Labor Relations Review 65.3 (2012): 501-532.

Tsoukis, Christopher, George Kapetanios, and Joseph Pearlman. “Elusive Persistence: Wage and Price Rigidities, the New Keynesian Phillips Curve and Inflation Dynamics.” Journal of Economic Surveys 25.4 (2011): 737-768.