Nominal wage

Development of nominal and real wages in Germany
Change in nominal and real wages in Germany

Under nominal wage the fee paid in money is meant for work that no statements about the purchasing power of money (monetary value) permits, since - in contrast to the real wage changes in the - price levels in the form of inflation or deflation will not be considered.

The aggregated nominal wage (cash wage) is the average amount that an average employee receives transferred to their account at the end of a month. The level of the nominal wage is determined on the one hand from wage negotiations on the employee and employer side and on the other hand from various macroeconomic parameters.

Historical and systematization

A theory to explain and quantify the relationship between wage levels and employment is provided by Wolfgang Franz , who has examined new findings on this issue at the micro and macroeconomic level. In the 1970s and 1980s, economists made particular efforts to define a variety of behavioral equations for large-scale macroeconomic projects. These efforts proved exaggerated in hindsight due to imbalances. Today, large-scale macroeconomic models tend to be neglected, because on the one hand it is difficult to transfer the model assumptions to an economy, and on the other hand quantification problems can arise for some characteristics. The effects on unemployment and employment in an international context are therefore increasingly being examined. Wage policy must now increasingly direct its responsibility towards the international integration of the labor, financial and goods markets and the accelerated technical progress caused by the introduction of rapidly expanding information and communication technologies and a global division of labor.

As part of a systematization, a distinction is made between gross and net nominal wages. A nominal gross wage (wages including taxes and social security contributions) represents the wage agreed between the employee and the employer. The net nominal wage (colloquially nominal wage) is the amount remaining after deduction of taxes as well as contributions to social security and private provision that the employee is actually gets paid. Economic subjects who do not recognize the connection between nominal and real wages are subject to the illusion of money .

An example calculation based on percentages in the economic area of ​​the Federal Republic of Germany explains the relationship:

Since the nominal wage is generally the payment for the production factor labor, different forms of wages are distinguished. There is the time wage , which is measured according to the number of hours worked, or the piecework wage based on the quantity produced . Terms such as the premium wage for blue-collar and white-collar workers, the entrepreneur's wages for entrepreneurial, dispositive activities and the investment wage are also used.

The methods of determining nominal wages

The level of nominal wages is determined primarily through collective wage negotiations in the form of collective bargaining between employees ( trade union ) and employers ( employers' association ) and partly through individual wage negotiations in the form of general declarations.

When determining the nominal wages individually, the wage level can be based on the specifications of the employer or the employee or on joint negotiations between the employee and the employer. The procedure is very variable depending on the historical episode, the qualification level and the country specifications. However, there is a general theory.

On the one hand, it is assumed that the nominal wage is mostly above the reservation wage, ergo the wage rate that is indifferent between the alternatives of employment or unemployment . This is higher, the more goods and services the employee can afford without an employment relationship. On the other hand, the principle states that the wage level depends on the situation on the labor market , i.e. the lower the unemployment, the higher the wages and vice versa.

There are two approaches to explain the general observations:

The first approach is to be found on the side of the workers , whose wage negotiations are dependent on their bargaining power.

This is determined on the one hand from the costs that the company would incur if the employee leaves the company and on the other hand from the substitutability of the employee, i.e. how difficult it is for the employee to find a new job. The higher the costs the company would incur if the employee left the company and the easier it is for the employee to find new employment, the greater his bargaining power. For example, a well-trained worker who knows the company's processes well has greater negotiating power and can enforce higher wage demands.

The bargaining power is also determined by the situation on the labor market. When unemployment is low, it is difficult for companies to get skilled workers into the company and at the same time it is easier for workers to find and enter alternative employment. The increasing bargaining power has an impact on the correspondingly higher wage demands.

In addition to the employees' interests in raising wages on the basis of their negotiating position, in a second approach employers have an interest in paying wages above the reservation wage. Reasons for this behavior on the part of employers are primarily the productivity and motivation of the employees, with the positive result that there is a reduction in fluctuation and the company is more attractive to its employees.

A conclusion at this point shows that nominal wages are not fully flexible, since the forms of wage negotiations at least almost define the lower wage limit.

Creation of nominal wages (influencing factors)

The nominal wage is described with the variable W (from English: wages = wage, salary) in economics. The level of the nominal wage is determined by three influencing factors - such as the functional relationship.

The function for the nominal wage is:

${\ displaystyle W = P _ {\ mathrm {e}} \ cdot F (u, z)}$

With

W = aggregated nominal wage
${\ displaystyle P _ {\ mathrm {e}}}$ = expected price level
u = unemployment rate
z = collective variable

The expected price level

The first determining factor for nominal wages is the expectation of the future price level.

The price level represents the demarcation of the nominal wage and the real wage. The decisions of households and companies are based on real and not nominal values, since households want to know how much goods and services they can actually buy with their available wages and companies are interested it is what nominal wages they pay in relation to the price of the output produced. Because nominal wages are usually set for a period of one year in advance and the actual price level can only be assumed until then, expectations about the price level must be taken into account at the time of wage negotiations.

The positive relationship between the nominal wage and the expected price level leads to proportionality. If the expected price level rises above that assumed in the wage negotiations, the nominal wage demands of the households adjust upwards accordingly, so that the nominal wage demands rise as the price level rises (inflation).

In the event of a falling price level (deflation), households' nominal wage demands fall. Companies are ready to vary nominal wages according to the price level. If the expectations of the employees corresponded to those of the companies, real wages would remain constant and the standard of living would not have to change.

The unemployment rate

Another determining factor for the level of the nominal wage is the unemployment rate . This connection has already been discussed in more detail in Section 2 under the subject of wage negotiations.

In summary, there is a negative relationship between the nominal wage and the unemployment rate. The falling negotiating position of employees in the scenario of rising unemployment - on the one hand due to the easier replacement of employees and on the other hand due to the difficulty of employees in finding alternative employment - leads to a decrease in nominal wage claims. On the employer's side ( efficiency wage theory ), lower wages with high unemployment do not lead to a loss of motivation for employees and lower nominal wages are enforceable.

In the opposite case - with low unemployment - both the increased negotiating position of the employees and the higher efficiency wages to be paid by the employers lead to an increase in nominal wages.

The collective variable

The third influencing variable - the collective variable  z  - includes all other factors, such as the amount of unemployment benefit , a statutory minimum wage , social assistance or provisions on protection against dismissal , which have a positive effect on the level of the nominal wage.

The positive dependency between the nominal wage and the collective variable ensures that the reservation and nominal wages are also increased when unemployment benefits, social assistance or statutory minimum wages rise. The reason for this is that if there was no adjustment, the employees would not be motivated to work, but would prefer unemployment . The same consequences arise if the negotiating position of employees increases due to tightened conditions in terms of protection against dismissal.

However, using the model generates criticism and inconsistencies. Inflation rates in most industrialized countries have  fallen since the 1990s - in line with the objectives of the central banks in the Stability Act - but nominal wages have a fixed downward effect.

According to the model, nominal wages would have to fall at a low price level. However, both psychological approaches (fairness, illusion of money) and institutional justifications (collective wage negotiations, labor law) mean that nominal wages are rigid downwards.

According to Akerlof / Dickens / Perry , this observation leads to a rise in unemployment - despite falling price levels in connection with nominal wages that are rigid downwards. If, for example, the demand for goods decreases in an economy, then the entrepreneurs either have the option of reducing the workforce or they can - while retaining the workforce - lower real wages.

In an environment with a comparatively high price level (inflation), this adjustment can take place in such a way that nominal wages grow at a lower rate than the price level.

Example: inflation rate = 4%
Nominal wage increase = 1.5%
→ Change in real wages of "(1.015 × 0.96) - 1" = −2.56%

In this scenario, no resistance from the workforce is expected as nominal wages rise.

However, if inflation is low - as in most industrialized nations - real economic consequences can be expected, which will lead to contradictions among employees.

Example: inflation rate = 1%
Nominal wage increase = 1.5%
→ Change in real wages of "(1.015 × 0.99) - 1" = 0.485%

At this point, the companies cannot fully implement the nominal wage reductions for the reasons mentioned. At the same time, entrepreneurs only have the option of dismissal and downsizing, which increases unemployment.

Although nominal wages do not fall due to the lack of adjustment to the price level, contrary to the ideas of the model, the unemployment rate increases. This phenomenon requires special explanation in the context of the Phillips curve , which describes the connection between inflation and the unemployment rate in more detail.

Fixing prices

Assumptions for setting nominal wages

1. Assumption

The prices that a company charges depend on the costs, above all on the costs of the input used and on the company's production methods.

2. Assumption

Companies only produce with one production factor, the production factor labor. This assumption can be described by the following function:

→ Production function: where the variables used mean the following: ${\ displaystyle Y = A \ cdot N}$

Y = production; A = labor productivity; N = employment

The labor productivity A is constant (for example: A = 1), so that an employee produces exactly one unit of output . The simplified production function is:

${\ displaystyle Y = N}$

The cost of an additional unit of production - assuming perfect competition ( perfect market ) - corresponds exactly to the cost of employing an additional worker. In microeconomics , these are defined as marginal costs . The price of a unit of production is equal to the wage rate W :

${\ displaystyle P = W}$

In the event of imperfect competition on the goods markets, companies take their market power into account when setting prices by adding a premium μ on the marginal costs. This surcharge is greater, the less elastic the demand reacts to price increases. The price is a factor (1 + μ) above the wage rate W:

${\ displaystyle P = (1+ \ mu) \ cdot W}$

The wage setting equation

The wage setting function is the result of the negotiation process between the parties to the collective bargaining agreement, employees and employers.

The wage setting equation (WS = wage setting ) can be derived from the function on nominal wages already presented .

The expected price level P e is equated with the actual price level P.

The wage setting has the form:

${\ displaystyle W = P \ cdot F (u, z)}$

Since, as already explained, the decisions of households and companies depend on real values, the function must be modified in such a way that both sides are divided by the price level P and the real wage determines the function.

The wage setting equation is:

${\ displaystyle {\ frac {W} {P}} = F (u, z)}$

The pricing equation

The price setting behavior of the entrepreneurs described under the third assumption is transformed into such a way that the equation can be carried out with the wage setting function. In this way, changes in the variables influencing the nominal wage can be measured.

First, the price setting equation (PS = price setting ) must be divided by the nominal wage W under the conditions of incomplete competition . This transformation leads to the following equation:

${\ displaystyle {\ frac {P} {W}} = (1+ \ mu)}$

The market power of the companies is shown in the form that the ratio of price level to nominal wage is exactly one plus the profit markup.

To create the uniform structure for the wage setting equation, the reciprocal value must be formed:

${\ displaystyle {\ frac {W} {P}} = {\ frac {1} {(1+ \ mu)}}}$

By equating the two formulas (PS = WS), the labor market equilibrium can be determined.

PS:

${\ displaystyle {\ frac {W} {P}} = {\ frac {1} {(1+ \ mu)}}}$

WS:

${\ displaystyle {\ frac {W} {P}} = F (u, z)}$

PS = WS:

${\ displaystyle {\ frac {1} {(1+ \ mu)}} = F (u, z)}$

The labor market equilibrium results from the calculation. The coordinates of the intersection between the price-setting and wage-setting functions are denoted on the abscissa as equilibrium unemployment ( natural unemployment ) and on the ordinate as equilibrium real wages. ${\ displaystyle \ left (u_ {n}, {\ tfrac {W} {P}} \ right)}$

To put it verbally, there is equilibrium on the labor market when the real wage according to the wage setting function is equal to the real wage according to the price setting equation.

example

The MAKRO company operates in markets with incomplete competition. Due to its market power, it charges a profit margin of 10% at its expense. The equation for wage setting has the form: W = P · 2 · [(1- u ) · 0.8] ².

The natural unemployment rate and the equilibrium real wage can be determined from this information:

Price setting equation PS Wage setting equation WS

${\ displaystyle {\ frac {W} {P}} = {\ frac {1} {(1+ \ mu)}}}$ ${\ displaystyle {\ frac {W} {P}} = {\ frac {1} {(1 + 0 {,} 10)}}}$

${\ displaystyle {\ frac {W} {P}} = 0 {,} {\ overline {90}}}$

${\ displaystyle W = P \ cdot 2 \ cdot \ left [(1-u) \ cdot 0 {,} 8 \ right] ^ {2}}$ ${\ displaystyle {\ frac {W} {P}} = 2 \ cdot (1-u) ^ {2} \ cdot 0 {,} 64}$

${\ displaystyle {\ frac {W} {P}} = 1 {,} 28 \ cdot (1-u) ^ {2}}$

Labor market equilibrium

(PS = WS):

${\ displaystyle 0 {,} {\ overline {90}} = 1 {,} 28 \ cdot (1-u) ^ {2}}$

${\ displaystyle 0 {,} {\ overline {90}} / 1 {,} 28 = (1-u) ^ {2}}$

${\ displaystyle 0 {,} 7102 {\ overline {27}} = (1-u) ^ {2}}$

${\ displaystyle {\ sqrt {0 {,} 7102 {\ overline {27}}}} = (1-u)}$

${\ displaystyle u = 1 - {\ sqrt {0 {,} 7102 {\ overline {27}}}}}$

${\ displaystyle u = 1-0 {,} 84275}$

${\ displaystyle u = 0 {,} 15725}$

${\ displaystyle u = 15 {,} 725 \, \%}$

Natural / equilibrium unemployment is 15.725%. The corresponding equilibrium real wage is:

${\ displaystyle {\ frac {W} {P}} = 1 {,} 28 \ cdot (1-u) ^ {2}}$
${\ displaystyle {\ frac {W} {P}} = 1 {,} 28 \ cdot (1-0 {,} 15725) ^ {2}}$
${\ displaystyle {\ frac {W} {P}} = 0 {,} {\ overline {90}}}$
The graphic representation of the price and wage setting function using the example

At this point, it is possible to draw conclusions about the nominal wage:

${\ displaystyle W = {\ frac {W} {P}} \ cdot P}$

If the net nominal wages rise faster than the prices, this leads to an increase in real wages and thus to an increase in purchasing power.

If prices rise faster than the net nominal wages, this leads to a loss of real wages and thus a loss of purchasing power.

In Germany in the past few years, increases in nominal wages have been eaten up by inflation, i.e. changes in the price level.

literature

• Hans Bühler, Bernd Harhoff, Axel Israng: General economics. Bildungsverlag E1ns, Troisdorf 1990, ISBN 3-8237-0119-3 .
• Oliver Blanchard, Gerhard Illing: Macroeconomics. Pearson Studium, Munich 2006, ISBN 3-8273-7209-7 .
• Wolfgang Franz: Labor Economics. Springer-Verlag, Berlin / Heidelberg / New York, ISBN 3-540-00359-2 .
• Thomas Beissinger, Christoph Knoppik: Are nominal wages rigid? Recent Evidence and Economic Policy Implications. Technical University of Kaiserslautern, 2003, . (Economic discussion contributions No. 17)
• Meinulf Kolb: Personnel Management. Berliner Wissenschafts-Verlag, 2002, ISBN 3-8349-0907-6 .

Individual evidence

1. a b
2. Federal Agency for Civic Education
3. Oliver Blanchard, Gerhard Illing: Macroeconomics. Pearson Studium, Munich 2006, ISBN 3-8273-7209-7 , p. 189.
4. ^ A b Wolfgang Franz, Knut Gerlach, Olaf Hübler: Wages and Employment: What do we know more than 25 years ago? (PDF; 67 kB) In: Communications from labor market and occupational research. 4/2003, pp. 399-410.
5. ^ Meinulf Kolb: Personnel Management. Berliner Wissenschafts-Verlag, 2002, ISBN 3-8349-0907-6 , p. 262.
6. Wissen.de ( Memento of the original from June 11, 2008 in the Internet Archive ) Info: The archive link was inserted automatically and has not yet been checked. Please check the original and archive link according to the instructions and then remove this notice.
7. See: Wolfgang Franz: Arbeitsmarktökonomik. Springer-Verlag, Berlin / Heidelberg / New York, ISBN 3-540-00359-2 , p. 275.
8. Oliver Blanchard, Gerhard Illing: Macroeconomics. Pearson Studium, Munich 2006, ISBN 3-8273-7209-7 , p. 184.
9. Oliver Blanchard, Gerhard Illing: Macroeconomics. Pearson Studium, Munich 2006, ISBN 3-8273-7209-7 , p. 185.
10. Oliver Blanchard, Gerhard Illing: Macroeconomics. Pearson Studium, Munich 2006, ISBN 3-8273-7209-7 , pp. 185f.
11. ^ Wolfgang Franz: Arbeitsmarktökonomik , Springer-Verlag, Berlin / Heidelberg / New York, ISBN 3-540-00359-2 , p. 275.
12. a b Oliver Blanchard, Gerhard Illing: Macroeconomics. Pearson Studium, Munich 2006, ISBN 3-8273-7209-7 , pp. 185ff.
13. a b Beissinger, Knoppik: Are nominal wages rigid? 2003, p. 5ff.
14. page no longer available , search in web archivesInfo: The link was automatically marked as defective. Please check the link according to the instructions and then remove this notice.
15. a b Bühler u. a .: General economics. 1990, ISBN 3-8237-0119-3 , p. 369.
16. Economic miracle .  ( Page no longer available , search in web archivesInfo: The link was automatically marked as defective. Please check the link according to the instructions and then remove this notice. In: FTD