What is the relationship between labor productivity and wage rates

The Productivity–Pay Gap | Economic Policy Institute

what is the relationship between labor productivity and wage rates

The point at which the MRPL equals the prevailing wage rate is the labor market . If the demand curve shifts to the right, either because productivity or the price of . used in labor economics to analyze the relation between the wage rate and . Keywords: Labour productivity, Marginal productivity of labour, wage-cut policy, through the increase of wage rate. positive relation between productivity and. Aug 14, Someone asked me: Why does productivity matter to wage growth? That four- percentage-point difference in labor's share of income between then and now Since , productivity's annual growth rate is about 1 percent.

Assume, for example, that there is a large group of workers who would be approximately indifferent between working as plumbers, carpenters, and electricians. Assume also that, initially, all three receive the same wage rate. Now, if productivity rises among electricians, there will be an increase in demand for electricians.

what is the relationship between labor productivity and wage rates

In the short run, say a year or two, it will not be possible to train additional electricians and wages may be bid up. But, when wages are higher among electricians than among plumbers and carpenters, students graduating from high school will prefer to train as electricians.

Soon, the supply of new electricians will increase and the supply of new carpenters and plumbers will decrease. Wages will fall among electricians and will rise among plumbers and carpenters. Ultimately, the wages of all three occupations will equalize. All three will enjoy higher wages than they did initially. But, among plumbers and carpenters this will have occurred without any increase in productivity.

The Connection between Labour Productivity and Wages

And, among electricians, the wage increase will have been much smaller than the productivity increase, because the effect of that increase will have been diluted by the influx of workers from other occupations. Indeed, if the initial number of electricians had been considerably smaller than the number of plumbers and carpenters, it is possible that the wage increase experienced by all three groups would have been negligible. The number of workers who would have to leave the plumbing and carpentry trades would have been so small, relative to the total numbers in those trades, that their exit would have had very little effect on wages in those occupations.

The primary effect of the productivity increase among electricians is that the number of electricians will increase and the numbers of plumbers and carpenters will decrease. Similar effects can be seen in other industries. The primary reason is that every increase in demand for fast food workers has been met by an influx of workers from other unskilled industries. This is not to say that there is no connection between productivity and wages at the industry level.

If the number of workers in an industry is not responsive to changes in wages, an increase in productivity may produce a permanent wage increase. There may, for example, be institutional barriers preventing additional workers from entering an industry — such as union regulations or restrictions on the numbers of students training for that industry at university or college.

Alternatively, there may simply be a limited number of individuals who have the aptitude to enter certain industries or occupations. Once that number had been exhausted, further wage increases might not call forth additional labour supply. Theory — National Wage Levels Even if there is only a limited connection between wages and productivity at the industry level, there may still be a strong connection at the national level.

When productivity gains drive up wages in one industry or occupation, it is anticipated that workers will be drawn from other industries and occupations, thereby returning relative wages to their initial level.

If productivity increases at the national level, however, the equivalent effect would require that workers be drawn from other countries. But, as Canada restricts the number of immigrants, this effect will be much less important for national wage levels than it was for industry wage levels.

Also, a productivity gain at the national level is less likely to lead to a reduction in output prices than is an equivalent gain at the industry level. When output increases in an industry, everything else being constant, the industry may have to lower prices in order to sell that increase.

When output increases in the nation as a whole, however, all workers will have higher incomes and those incomes may be used to purchase the increased output. Prices need not fall. That is, even if observed or nominal wages do not change, workers will be able to buy more goods and services with their incomes.

Here is the basic logic taught in economics textbooks: Economic theory says that the wage a worker earns, measured in units of output, equals the amount of output the worker can produce. Otherwise, competitive firms would have an incentive to alter the number of workers they hire, and these adjustments would bring wages and productivity in line.

If the wage were below productivity, firms would find it profitable to hire more workers. This would put upward pressure on wages and, because of diminishing returns, downward pressure on productivity. Conversely, if the wage were above productivity, firms would find it profitable to shed labor, putting downward pressure on wages and upward pressure on productivity. The equilibrium requires the wage of a worker equaling what that worker can produce.

There are a several reasons: The relevant measure of wages is total compensation, which includes cash wages and fringe benefits. Some data includes only cash wages. In an era when fringe benefits such as pensions and health care are significant parts of the compensation package, one should not expect cash wages to line up with productivity. The price index is important.

Greg Mankiw's Blog: How are wages and productivity related?

Productivity is calculated from output data. From the standpoint of testing basic theory, the right deflator to use to calculate real wages is the price deflator for output. Sometimes, however, real wages are deflated using a consumption deflator, rather than an output deflator.

To see why this matters, suppose hypothetically the price of an imported good such as oil were to rise significantly. A consumption price index would rise relative to an output price index.

Real wages computed with a consumption price index would fall compared with productivity.

what is the relationship between labor productivity and wage rates