Sticky-Wage Theory of SRAS
What is Sticky-Wage Theory of SRAS?
The sticky-wage theory says SRAS slopes upward because nominal wages adjust slowly, so a higher price level raises firm profits and output in the short run.
Because many wages are fixed by contracts or norms, they do not change immediately when the price level rises. When output prices increase but wages stay put, real labor costs fall and profit margins widen, so firms hire more and expand production. This effect is temporary: once wage contracts are renegotiated to reflect higher prices, real wages and output return to the long-run level, which is why LRAS is vertical. It is one of three standard explanations (along with sticky-price/menu-cost and misperceptions) for the upward-sloping SRAS.
Sticky-Wage Theory of SRAS: a worked example
A factory signs a two-year contract at $20 per labor hour. Each unit of output takes two hours, so unit labor cost is $40, and the firm sells the unit for $50, a $10 margin. The price level then rises 10 percent and the firm's output price goes to $55. The contract pins the wage at $20, so unit labor cost stays $40 and the margin jumps to $15, a 50 percent increase. The real wage has fallen: $20 divided by 1.10 buys about $18.18 worth of the old basket, roughly 9 percent less. Chasing that wider margin, the firm adds a shift and lifts output from 800 units to 920. When the contract is renegotiated at $22, unit labor cost climbs to $44, the margin settles at $11 on a $55 price, the same 20 percent of revenue as before, and output falls back to 800.
The mistake students make with sticky-wage theory of sras
Students describe the sticky-wage story as a rightward shift of SRAS. The mechanism sounds like a cost decrease, and cost decreases shift supply, so the leap feels natural. But nothing about the curve moved: the nominal wage was fixed and the price level changed, which is a movement along SRAS from one point to another. A shift needs the nominal wage itself to change, as happens when contracts are renegotiated. The second slip is claiming the real wage rose. Workers holding a fixed nominal wage while prices climb earn less in real terms, and that is precisely why firms hire more.
Sticky-Wage Theory of SRAS questions
Why do sticky wages make SRAS slope upward?
Nominal wages locked in by contracts cannot respond immediately when the price level rises. Firms sell output at higher prices while still paying the old wage, so real labor cost per unit falls and profit margins widen. Wider margins make it worth hiring more workers and running extra shifts, so real output rises alongside the price level. Plot output against the price level and that positive relationship is the upward-sloping short-run aggregate supply curve.
What happens to the sticky-wage effect in the long run?
Contracts expire and get renegotiated. Once workers bargain for wages reflecting the new price level, nominal wages rise in proportion, real labor cost per unit returns to where it started, and the temporary margin disappears. Hiring falls back and the extra shifts end, leaving output at potential, which is why long-run aggregate supply is drawn vertical. The higher price level sticks around, but the extra output does not.
How is sticky-wage theory different from sticky-price theory?
Sticky wages concern the cost side of the firm, sticky prices the revenue side. Under the wage story, a fixed nominal wage plus a rising price level widens margins, so firms expand. Under the price story, some firms leave their own posted prices unchanged because changing them costs money, so those firms become relatively cheap and sell more units. Both deliver an upward-sloping SRAS, but graders want the specific channel named rather than a vague appeal to slow adjustment.
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