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Question about Saif’s explanation of Inflation -> Unemployment
Hi all, new to Econ here so this may be a rookie misunderstanding, but just want to get some inputs. Saif explains in chapter 4 that a worker’s marginal revenue product is directly proportional to the price of the product. i.e. if a worker works at a sandwich shop, their productivity is directly related to the price at which the shop sells sandwiches. This makes perfect sense. Saif then explains that in times of inflation, workers will demand higher wages to make up for their increased cost of living. This also makes perfect sense. He then says that this leads them to have to lose their jobs, since they are now demanding more wage while their marginal productivity is the same. My question is: in inflationary times, wouldn’t their marginal productivity increase, as the price of the product increases? For example, if a sandwich shop can now sell sandwiches for higher price due to inflation, doesn’t that mean each worker’s marginal productivity has in fact increased and therefore they can receive a higher wage, instead of having to lose their job? Appreciate any inputs – thanks.
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3 Replies
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In Saif’s explanation we are assuming that the prices of sandwiches are staying the same but other prices are rising. In other words, inflation is affecting the cost of living of the sandwich workers because the goods that they spend their wages on are increasing but the sandwiches they make aren’t so they can’t have their wages risen because the sandwich prices have remained the same. This is why inflation redistributes wealth because the new money entering the economy is raising the prices of goods of where it is being spent and in Saif’s example, the new money never got to be spent on the sandwiches.
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Diego, thanks for your answer. One question, if we assume that the goods purchased by the sandwich shop workers will be increasing in price due to inflation, why do we assume that the sandwiches themselves will not be increasing in price due to inflation? Thus allowing workers to get paid higher wages.
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We assume that prices of sandwiches aren’t increasing but only their costs because the factors of production used by the sandwich shop are also factors of production that can be used in other lines of production. For example, the sandwich shop may be using the same machine as the burrito shop to make their products. In that case if the new money is spent on burritos, the burrito shop can use that extra money to bid for more machines (the same machine used by the sandwich shop). When the sandwich shop goes to repurchase a machine, it will witness a rise in the price of the machine due to the extra money that got into the hands of the burrito shop.
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