Question

Economists generally champion the forces of the free market and make the claim that shortages and surpluses are merely transitory and that eventually, prices will react in a way to eliminate them. Fair enough. However, why is it that wages do not appear to adjust in the same way during recessions and as a result, we experience prolonged periods of unemployment? What's going on here?

Answer 1

It is true that wages do not adjust as it is the case with the prices. But,there is a classical school of economics and economists who propose that wages are flexible in nature and it makes decrease in wages during recession and it is the basis of economic recovery as per classical approach that says that lower wages in recession, causes decrease in cost of production and short run aggregate supply increases and shifts to the right. It makes long run equilibrium to achieve. So, there are economists who believe that wages are flexible like prices. But, sadly it does not work and great depression of 1930s in the USA is the example of it where wages did not come and economy failed to recover on its own for a long period of time.

It was the time, when Keynes came up with his economic proposition that wages are sticky in nature and wages are based on contractual agreements. It makes individuals and employees to stick to the wages they receive and do not accept reduction in wages. It is the main reason that wages do not decrease during a recession. So, people resist lower wages and they continue to demand the wage they have received. It causes an increase in unemployment. Besides, another reason is the unemployment benefits received by people when they become unemployed. It works as a barrier and a mean of economic tradeoff. In this case, when individuals do not get wages that are higher than the unemployment benefits, they do not join the job and wage stickiness continues.  So, it is the different outcome to the prices where market forces push the price to achieve equilibrium if the government does not intervene.