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Jul 26, 2012

Business Cycles Explained: Sticky Wages & Prices

Tyler Cowen touched on the topic of Wage & Price Stickiness in “Business Cycles Explained: Keynesian Theory.” In this video, he dives deeper into these core ideas.

What makes wages sticky?

In many economies, a large portion of the workforce is unionized and wages are legally determined through a voting process. In these cases, if you want to unstick wages, you have to run the gauntlet of the political process.

In less unionized economies, wage stickiness hinges partially on expectations and morale. Cowen explains using “The Parable of the Angry Professor”: Out of all people, we would think that economics professors would advocate wage reduction in order to avoid unemployment.However, when the wages of the professors remain flat or decrease, morale falls flat. The results? Complaints, sub-par teaching, nasty departmental politics.

While wage stickiness is pervasive, it binds to some industries more than others. In commission based professional spheres, wage expectations are conditioned to adjust. When you work on commission, you expect income fluctuation—wages don’t stick. But in most professions, the opposite is true. Many workers are willing to work harder, even beyond employer expectations, for the security of consistent, predictable wages. While this security can boost productivity and morale, the promise of predictability translates into troublesome stickiness during economic downturns.

Wages aren’t the only sticking points—prices get sticky too. Why? One reason comes down to menu costs. The term “menu cost” originates from the costs associated with restaurants changing their prices. When a restaurant changes prices, they have to print new menus. Menus, or course, are not free! In order to avoid these menu costs, restaurants often stick with constant prices. And there you have your recipe for sticky prices!

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