Saturday, February 27, 2010

News Flash! China is experiencing wage inflation---MONTHLY minimun wage---$114!!

"Just a year after laying off millions of factory workers, China is facing an increasingly acute labor shortage. As American workers struggle with near double-digit unemployment, unskilled factory workers here in China’s industrial heartland are being offered signing bonuses.  Factory wages have risen as much as 20 percent in recent months."

Welcome, China, to the Short Run Aggregate Supply Curve.  China is experiencing "normal" inflation due to increasing wages as a result of moving closer to what is called "Full-Employment" Real GDP.  Economists define Full-Employment Real GDP as the dollar value of an economy's "potential" production, regardless of the price level.  Notice on the graph full-employment Real GDP ("FE RGDP") is fixed. 

This fixed point of potential GDP comprises the Long Run Aggregate Supply (LRAS) and is vertical at FE RGDP.   Any RGDP to the LEFT of the LRAS represents "Actual RGDP" (Point "RGDP1"). It means the economy is producing a Real GDP that is less than its potential ability to do so. It is "under-employing resources" and the main resource we care about is people.  At FE RGDP the unemployment rate is relativel low, but NOT zero!  Economists consider 0% unemployment to be actually about 5%, or the "Natural Rate of Unemployment".  If an economy can get to 5% unemployment it should consider itself at  full-employment.  The lower the Actual RGDP is relative to FE GDP the higher the unemployment rate (we have the presence of "cyclical unemploymnet"). As an economy increases its actual RGDP it consumes more societal resouces, labor included.  As you move closer to FE GDP, more people are employed and fewer and fewer skilled and unskilled workers are available. If business are still expanding, then they will have to compete with each other for ever-more scarce workers.  They do this by increasing wages, to attract AND retain existing workers.  Labor is the resource, according to the article, that is becoming more scarce, hence increasing wage rates.  Increasing wage rates are EXPECTED as a normal course as production moves closer to Full-Employment Real GDP. The effect of rising wages start to take effect in the graph (below) as we pass Real GDP5. This will increase the cost of producing, hence the transition from the horizonal section of the Short Run Aggregate Supply (SRAS) curve to the upward-sloping intermediate section of SRAS, up to Real GDP8.

You can see that price level increases as production is increased.  Again, it is important to remember that this is EXPECTED inflation and is built into the existing SRAS curve.  The problems arise when inflation is UNEXPECTED (creates "Stagflation"--more on that another time) and SHIFTS the SRAS curve to the left....Bottom line: China is moving along its Short Run Aggregate Supply Curve and is a normal condition as it reaches full-employment GDP. Problems arise when they (1) experience UNEXPECTED inflation (resource price shock, for example) OR (2) move BEYOND there Full-Employment capacity and ACTUAL unemployment goes below the Natural Rate of Unemployment...

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