Question

hi there!

I wanted to ask why does low unemployment cause nominal wages to rise and vice versa? thank you!

Answer 1

Think about it like this. Higher is the unemployment rate, lower are the opportunities available to work with respective to the number of people looking for work. Now think from the viewpoint of the employer, he knows that for a given job, there are numerous people who are willing to work (this happens because many people are unemployed and looking for work), so this gives very high bargaining power to the employer. This higher bargaining power of the employer gives him the power to negotiate a wage contract a lower nominal wage as the employer knows even if one worker declines to work at the lower wage, the other will agree due to surplus labor. Hence higher unemployment leads to lower nominal wages.

Vice-versa, if there is low unemployment, this means that there are for a given job, there are very few people willing to work. Hence the employer has very limited people to choose from and this in turn lowers his bargaining power. Or to think in other way around, the employer needs to pay higher wage to people to attract people to leave there current job and work for him. As a result the employer needs to offer higher nominal wages. Hence lower employment leads to higher nominal wages.