Discuss the impact of the reduction in money wages on the Productivity of labor (Q/L), the average cost of production (C/L), the total cost of production (C), and inflation.

THE CASE:

An application of the second-order differential equation with a macro model deals with the problem of inflation and unemployment. Phillips relation is the most widely used concept in the modern analysis of the problem of inflation and unemployment. Its original formulation depicts an empirically based negative relation between the rate of growth of money wage and the rate of unemployment. Its linear form can be written as:

W = α – βU

Where W is the rate of growth of money wage, and U is the unemployment rate.

Requirement:

Discuss the impact of the reduction in money wages on the Productivity of labor (Q/L), the average cost of production (C/L), the total cost of production (C), and inflation.

Solution:

The impact of a reduction in money wages on various macroeconomic variables is as follows:

• Productivity of labor (Q/L): A decrease in money wages may lead to a decrease in labor productivity if workers become demotivated and their morale is impacted negatively. However, if the reduction in wages is accompanied by an increase in investment in technology and training, then productivity may increase.

• Average cost of production (C/L): A reduction in money wages will result in a decrease in average cost of production as labor costs form a significant portion of total costs.

• Total cost of production (C): The reduction in average cost of production may not necessarily result in a reduction in total cost of production if the quantity of labor (L) used in production increases.

• Inflation: A reduction in money wages may result in lower inflation as workers' purchasing power decreases, and they will demand less goods and services. However, this impact may be offset by the decrease in productivity and increase in the quantity of labor used in production.

            In summary, the impact of reduction in money wages on the various macroeconomic variables is complex and depends on various factors such as the change in productivity, the change in the quantity of labor used in production, and the overall impact on the economy.