Economics is a field of study that looks at how human beings strive to meet their needs. It explains how individuals allocate the available resources to satisfy their endless demands, although limited. In business organizations, economics describes how they have to give their priorities to the resources in all stages of production. Therefore, we can deduce that economics deals with the production, distribution, and consumption of goods and services(Ehrenberg, Smith and Hallock, 2021, pg. 12). Economics has two broad areas;
- Microeconomics; explains how individuals strive to acquire resources to satisfy their needs and how, after receiving the resources necessary, one has to choose which need to meet before the other. It explains how individuals’ income affects their demand, buying ability, and choice products. It explains how individual income affects their living standards.
- Macroeconomics; refers to the performance of the whole economy in terms of employment rates, inflation, the value of the national income, and the general growth of the economy. It seeks to explain why there are high unemployment rates, high rise in prices of products, and the decline in peoples’ living standards. It gives insights into the changes in economic growth and the remedies to curb any loophole in the economic environment.
Demand refers to the willingness and ability to acquire a product or a service. With all factors affecting the market held constant, a product’s price and demand are related inversely. This explains that increased costs lead to decreased demand, and a decrease in price leads to an increase in demand. The buyer’s ability causes the reasons for changes in the market.
Aggregated demand refers to the final demand for the finished goods produced in a country at a specific period. The demand is determined by considering consumer spending, government spending, investment spending, imports, and exports. However, several factors affect the aggregated market, such as currency exchange rates, inflations, interest rates, and income. All these factors influence the aggregated demand positively or negatively.
Wages refer to the benefits receivable for a work or a service provided by an individual. It is a share that labor gets from the products of the industry or company. The wages can be piece wages; these are paid according to work done and the number of units produced, time wages; paid according to the time spent in the production process, cash wages; paid in cash form of money, wages in kind; where one is paid using other forms rather than cash, contract wages; where one’s wages are fixed until the completion of a task(Garin and Silvério, 2019, pg. 14).
In this essay, I will discuss why if wages fall, the result will not be an increase in aggregate demand and when this might not be the case. The statement means that if the industry provides lower pay to the production process workers, this increases the aggregated demand value. In most economies, the consumers of the final products are also involved in the production process. This means the income they accrue from the producing company is the same income they use to pay for the goods and services from the companies. Therefore, a decrease in their income will negatively affect their buying ability. If their buying ability decreases, the consumers have to decide by forgoing some products and consuming the most basic needs. This is a blow to the industry since it means a drop in the number of goods demanded.
In another dimension, reducing the wages paid to labor providers in a company means a minimized cost of production. If the industry can produce at low rates, they can price their goods as far as possible. A decrease in prices gives rise to increased demand.
The Keynesian theory tries to give the effects of factors such as employment, inflation, government, and consumer spending on the final product of an industry. Therefore, all these factors affect the demand for a product. The theory argues that most people will not accept wages that will not positively impact their living standards. People are ready to work for wages that will give them more power over their buying ability. According to the theory, unemployment will be inevitable if the wages are not favorable. The approach also explains that the industry should consider the demand in the market before production to ensure that the outputs will sell. According to the theory, reducing the wages paid to workers in an industry cannot necessarily mean increased aggregated demand. Firstly, if the reduction in wages affects consumer spending, then the market for the product will be lower. Secondly, the production of high output volumes without certainty in their existing demand will lead to lower needs(Marglin and Bhaduri, 1991, pg. 18).
Classical theories of economics argue that the economy is self-regulating. All the aspects and factors that affect the growth of an economy can self-align and produce a neutral economy where there is no competition between all the elements. It explains that all these factors can detect and provide solutions to problems arising from the economy. According to the theory, the wages are flexible in that if there is an emergency of the excess labor force, then the wages will self-adjust to take care of the excess labor. This is to mean that wages change with the demand for labor. The theory argues that the supply of money may not affect the demand for a product to consumers (Gordon, 1974, pg. 10).
In conclusion, the Keynesian theory argues that wages are rigid and workers are not ready to work at lower wages. This implies that any wage below the normal wage will force workers to decline employment, which will affect their spending. A decrease in their spending will thus lead to decreased demand for the industry output due to the decrease on the purchasing power. On the other hand, the classical theory holds that wages are flexible and always align with the prevailing market conditions. Therefore, if wages are reduced, it is possible to have an increased aggregated demand because the lower wages may be due to the market forces aligning to provide a solution in the market, for example, increased labor supply.
Ehrenberg, R.G., Smith, R.S. and Hallock, K.F. (2021) Modern labor economics: Theory and public policy. Routledge.
Garin, A. and Silvério, F. (2019) How responsive are wages to demand within the firm? evidence from idiosyncratic export demand shocks.
Gordon, D.F. (1974) ‘A neo-classical theory of Keynesian unemployment’, Economic inquiry, 12(4), p. 431.
Marglin, S.A. and Bhaduri, A. (1991) ‘Profit squeeze and Keynesian theory’, in Nicholas Kaldor and Mainstream Economics. Springer, pp. 123–163.