Final answer:
Wages tend to be 'sticky' downward due to various theories, including implicit contracts, efficiency wage theory, adverse selection, the insider-outsider model, and relative wage coordination, leading to persistent unemployment even with an excess supply of labor.
Step-by-step explanation:
Understanding Wage Stickiness in Labor Markets
In labor market economics, the concept of sticky wages refers to the observation that real wages tend to remain rigid or adjust very slowly, particularly in a downward direction, even when there is an excess supply of labor. This stickiness can lead to persistent unemployment levels. Various theories attempt to explain this phenomenon, including implicit contracts, efficiency wage theory, adverse selection of wage cuts, the insider-outsider model, and relative wage coordination.
Implicit contracts theory suggests that employers and employees have an unspoken agreement to keep wages stable to protect workers during economic downturns. Efficiency wage theory posits that higher wages can enhance productivity and reduce turnover. Adverse selection proposes that cutting wages may lead skilled workers to leave, reducing the overall quality of the workforce. The insider-outsider model considers the dynamics between employed workers ("insiders") and unemployed job seekers ("outsiders"), where insiders may have more bargaining power. Relative wage coordination highlights that workers are concerned with their earnings relative to their peers, which discourages wage cuts.
All these theories imply that wages are unlikely to fall quickly, if at all, despite changes in the economy or tough times for a business. As a result, the labor market experiences either short-run or long-run unemployment when these sticky wages are above the equilibrium level that would clear the labor market. This mismatch between the demand for labor and the supply of job seekers sustains the level of unemployment.