Final answer:
When aggregate demand declines, firms may cut employment rather than wages due to minimum wage laws, the potential for labor disputes, and overall negative impacts on worker productivity and consumer spending. These factors contribute to wage stickiness that can ultimately lead to unemployment when labor demand decreases.
Step-by-step explanation:
When aggregate demand declines, some firms may reduce employment instead of wages because wage reductions might not be legally possible due to the minimum wage law. This is particularly relevant for low-skilled workers who are earning at or near the minimum wage; legally, their wages cannot be reduced. Additionally, wage reductions can also lead to issues such as labor disputes or strikes, especially if there are existing union contracts. Beyond legal constraints, economic rationales also explain why wage cuts are less preferred. Such rationales include the idea that reducing wages could lead to a decrease in worker productivity or increase employee turnover, both of which have additional costs for firms.
Furthermore, there are instances where firms might not see a decrease in employment following a minimum wage increase because higher wages can result in higher worker spending. This increase in consumer spending can boost demand for goods and services, potentially offsetting the initial cost of higher wages by increasing demand for labor to meet the new demand for goods and services.
Conversely, if wages are sticky downwards, in times when labor demand decreases, firms may resort to cutting employment rather than lowering wages. This results in a gap between the number of workers willing to work at the current wages and the number of jobs available, causing unemployment. This outcome is graphically represented in economic models where the labor demand curve shifts to the left, and the sticky wages prevent necessary downward adjustments, leading to job losses instead of wage reductions.