हिंदी
CISCEISC (Arts) Class 12
प्रश्न पत्र३७९
पाठ्यपुस्तक उत्तर१६६८१
महत्वपूर्ण प्रश्न एवं उत्तर६२९२
अवधारणा स्पष्टीकरण और वीडियो९५८
समय सारणी१६
पाठ्यक्रम

Flexibility of wages Interests and Prices

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Estimated time: 19 minutes
  • Formula: Flexibility of Wages
  • Flexibility of Wages
  • Flexibility of Rate of Interest
  • Flexibility of Price Level
  • Key Points: Flexibility of Wages, Interests and Prices
CISCE: Class 12

Formula: Flexibility of Wages

\[RealWage=\frac{MoneyWage}{PriceLevel}\]

  • When real wages are low → hiring is cheaper → firms demand more labour
  • When real wages are high → more people want to work → supply of labour increases
CISCE: Class 12

Flexibility of Wages

Wages are decided in the labour market through the forces of demand and supply. Both depend on the real wage — the actual purchasing power of what a worker earns.

Demand & Supply Functions of Labour
The demand for labour (ND) is a decreasing function of real wage — as real wages go up, firms hire fewer workers:

The supply of labour (NSNS) is an increasing function of real wage — as real wages go up, more people want to work:​

Full employment happens when demand for labour equals supply of labour:

ND = NS

How Does Wage Flexibility Remove Unemployment?
When there is unemployment, supply of labour is more than its demand. Here is what happens step by step:

  1. Unemployed workers compete for jobs → money wages fall
  2. If prices stay the same (or fall less than wages), then real wages also fall
  3. Fall in real wages makes hiring cheaper → firms demand more labour
  4. More workers get hired → unemployment is removed
  5. Economy returns to full employment

Pigou's Equation
Prof. A.C. Pigou put this idea into a simple equation:​​

\[N=\frac{qY}{W}\]

Symbol Meaning
N Number of workers employed
qY Fraction of national income paid as the total wage bill (q = wage share, Y = national income)
W Money wage rate paid to each worker

What does this tell us?

  • If W increases (wages go up) → N falls (fewer workers get jobs from the same wage pool) → some workers become unemployed​
  • If W decreases (wages come down) → N rises (the same wage pool is shared among more workers) → unemployment is removed​

Pigou's warning: If trade unions or the government fix wages higher than what the market would set (i.e., above marginal productivity), unemployment will continue in the economy.

Diagram Explanation (Labour Market)

  • X-axis = Level of Employment | Y-axis = Wage Rate
  • DD = Demand curve of labour (downward sloping)
  • SS = Supply curve of labour (upward sloping)

Situation Wage Rate What Happens
At wage OW DD and SS meet at point E Demand = Supply → Full employment (ON workers employed)
Wage rises to OW₁ Only ON₁ workers demanded, but N₂ workers want to work Supply > Demand → Unemployment exists
Wage falls back to OW Unemployed accept lower wages All willing workers get jobs → Full employment restored
Wage falls to OW₂ Demand (ON₂) exceeds Supply (ON₁) Labour shortage → wages rise back to OW
CISCE: Class 12

Flexibility of Rate of Interest

What Role Does Interest Rate Play?
In the classical model, the interest rate acts as the balancing force between savings and investment:​

  • Saving (S) = income that people do not spend (supply of funds)
  • Investment (I) = money that businesses borrow to produce goods (demand for funds)

The Equations

I = f(r)
Investment is an inverse function of interest rate — when interest rate is high, borrowing is costly, so investment is less.​

S = f(r)
Saving is a direct function of interest rate — when interest rate is high, saving is more rewarding, so people save more.​

Equilibrium condition:

S = I
When savings equal investment, the economy is balanced and at full employment.​

How Does Interest Rate Flexibility Remove Unemployment?
If there is unemployment, it means investment is less than saving (I < S). In other words, people are saving too much and spending too little. Here is how the economy self-corrects:

  1. Savings exceed investment (S > I) → surplus of money in the market
  2. Rate of interest falls (just like the price of anything in surplus falls)
  3. Low interest rate → discourages saving (less reward for keeping money idle)
  4. Low interest rate → encourages investment (cheaper to borrow)
  5. Investment rises → more production → more jobs → full employment restored​

The opposite also works: if interest rate is too low (I > S), demand for funds exceeds supply, so the interest rate rises until S = I again.

Diagram Explanation (Capital Market)

  • X-axis = Savings and Investment | Y-axis = Rate of Interest
  • DD = Demand curve of capital (Investment curve)
  • SS = Supply curve of capital (Saving curve)

Situation Interest Rate What Happens
At rate OR DD and SS meet at point E S = I → Equilibrium in goods market
Rate rises to OR₁ Saving increases, Investment decreases (S > I) Surplus funds → interest rate falls back to OR
Rate falls to OR₂ Investment increases, Saving decreases (I > S) Shortage of funds → interest rate rises back to OR

Flexibility of Price Level

Connecting Money Supply to Prices
Classical economists used the Quantity Theory of Money to explain how prices are determined. The equation is:

MV = PT

Symbol Meaning
M Supply of money in the economy
V Velocity of circulation (how many times each rupee changes hands)
P General price level
T Total goods traded (volume of transactions)
  • Left side (MV) = Aggregate Demand (total spending in the economy)
  • Right side (PT) = Aggregate Supply (total value of goods available)

In equilibrium: Aggregate Demand (MV) = Aggregate Supply (PT)

If V (velocity) and T (transactions) stay constant, then:

P = f(M)...(1)

This is the Quantity Theory of Money — it says that the price level depends directly on the money supply.

How Does Price Flexibility Remove Unemployment?
When there is unemployment in the economy:

  1. Money wages fall (as explained in Section 1)
  2. Lower wages → lower cost of production → price level falls
  3. If total demand (MV) stays the same and trade (T) is constant, then fall in prices means real income rises
  4. Higher real income → more demand for goods
  5. More demand → firms produce more → more employment
  6. This continues until full employment is reached

Important condition: The fall in money wages must be greater than the fall in prices. Only then will real wages actually fall, making it worthwhile for firms to hire more workers.​

Diagram Explanation (Money Market)

  • X-axis = Price Level | Y-axis = Real Income / Output
  • M₁ curve and M₂ curve show the relationship between price level and real income at different money supply levels

Situation Money Supply Price Level Real Income What Happens
Initial equilibrium M₁ OP₁ OY₁ (full employment) Economy at full employment
Money supply increases to M₂ M₂ OP₂ (rises) OY₁ (unchanged) Only prices rise; real output stays the same since economy is already at full employment
CISCE: Class 12

Key Points: Flexibility of Wages, Interests and Prices

  • Flexible wages: Fall in money wages reduces real wages, increases demand for labour, and removes unemployment.
  • Flexible interest rate: Fall in interest rate reduces saving and increases investment, restoring full employment.
  • Flexible prices: Fall in prices raises real income and demand, increasing output and employment.
  • Conclusion: Flexibility of wages, interest, and prices automatically ensures full employment in the economy.

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