The Classical Labor Market and the Fallacy of Composition

In an economy with full employment, if I am asking too high a nominal wage for my labor, I can reduce that request and find work. That truth is behind the classical labor-market model.

That the above is true does not mean that all workers can reduce their real wage requests and find work. First of all, workers cannot directly negotiate real wages. They can only lower their nominal wage requests. And if all workers do so, this will surely lower nominal aggregate demand. Which, in turn, can lower real output, so that the new nominal wage level is still "too high," and unemployment persists.

1 comment:

  1. "They can only lower their nominal wage requests. And if all workers do so, this will surely lower nominal aggregate demand"

    It might lower aggregate demand but surely this is not certain because

    1. Depending upon the elasticity of demand for labor then it might actually lead to sufficiently more workers being hired that a net increase in aggregate demand occurs

    2. If lowering wages increases profit margins then more employers may be attracted to buy more labor. (I'm not sure if this is just #1 stated differently ?)

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