What is wage - price spiral? A correlation between Wage and Price

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Wages and prices change every day. If the demand for smartphones rises at the same time that demand for laptops falls, we would expect to see a rise in the price of smartphones and a fall in the price of laptops. Wages in the smart phone industry would tend to increase, and wages in the laptop manufacturing industry would tend to fall. Sometimes, we see wages and prices in all industries rising or falling together. For example, prices for steel, automobiles, food, and fuel may all rise together. Why? Wages and prices will all tend to increase together during booms when GDP exceeds its full-employment level or potential output. Wages and prices will fall together during periods of recessions when GDP falls below full employment or potential output.

If the economy is producing at a level above full employment, firms will find it increasingly difficult to hire and retain workers, and unemployment will be below its natural rate. Workers will find it easy to get and change jobs. To attract workers and prevent them from leaving, firms will raise their wages. As one firm raises its wage, other firms will have to raise their wages even higher to attract the workers that remain. Wages are the largest cost of production for most firms. Consequently, as labor costs increase, firms have no choice but to increase the prices of their products. However, as prices rise, workers need higher nominal wages to maintain their real wages. This is an illustration of the real-nominal principle. This process by which rising wages cause higher prices and higher prices feed higher wages is known as a wage–price spiral . It occurs when the economy is producing at a level of output that exceeds its potential. When the economy is producing below full employment or potential output, the process works in reverse. Unemployment will exceed the natural rate. Firms will find it easy to hire and retain workers, and they can offer workers less. As all firms cut wages, the average level of wages in the economy falls. As we have said, wages are the largest component of firms’ costs. So, when wages fall, prices start to fall, too. In this case, the wage–price spiral works in reverse.

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