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 benefits Total 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 D L = f (W)  labor demanded given the changes in W Relation (slope) NEGATIVE Changes in W  changes upon the curve Also, changes in other factors / forces that affect D L (D C, P K, P i, 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  P C up  D C down  Y C down  D L down Scale effect: employment effect of a change in the scale of production... but also... 2)If W up  D K up (with P K fixed)  new technology  D L 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 P K : how it affects the no. of employees? 1)If P K down  costs down  P C down  D C up  Y C up  D L up Scale effect: as before, the employment effect of a change (increase) in the scale of production, and also... 2)If P K down  D K up  new technology  D L 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