Most ‘wages in America and other marketeconomies are administered by firms or contracts. Wages and salaries are set infrequently and adjust. to meet shortages or surpluses only over an extended period of time
Let’s go a step further and ask, What is the economic reason for the .sluggishness of wages and salaries? Many economists believe that the inflexibility arises because of the costs of administering compensation (such costs are called “menu costs”). To take the example of union wages, negotiating a contract is a long process that requires much worker and management time and produces no output. It is because collective bargaining is so costly that such agreements. are generally negotiated only once every 3 years. Setting compensation for nonunion workers is less costly,but it nevertheless requires scarce management time and has important effects on worker morale. EVerytime wages or salaries are set; every time fringe
Personnel managers therefore prefer a system in rhich wages are adjusted infrequently and· most workers in a firm get the same pay increase, regardess of the market conditions for different skills or categories. This system may of wages to reflect market supply and demand. But it does economize on scarce man appear inefficient to economists, because it does not allow for a perfect maladjustment time and helps promote a’sense of fair play and equity in the firm. In the end, it may be cheaper to recruit workers more actively or to change the required qualifications than to upset the entire wage structure of a firm simply to hire a few new workers.
The theory of sticky wages and involuntary unemployment holds that the slow adjustment of wages produces surpluses and shortages in individual labor, markets. Labor markets are non clearing markets in the short run. But labor markets do eventually respond to market conditions as wages of high -demand occupations move up relative to those of low-demand occupations. In the long run, major pockets of unemployment and job vacancies tend to ‘disappear as wages and employment adjust to market conditions .. But the long run may be many years, and periods of unemployment can therefore persist for Illany years