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How to Calculate Equilibrium Real Wage Rate
The equilibrium real wage rate is the specific wage level, adjusted for inflation, where the quantity of labor supplied by workers exactly matches the quantity of labor demanded by employers. At this point, there is neither a surplus of labor (unemployment) nor a shortage of labor.
The Core Formula
In a linear labor market model, we represent demand and supply as follows:
- Labor Demand (LD): a – b(W/P)
- Labor Supply (LS): c + d(W/P)
Equilibrium Real Wage (W/P)* = (a – c) / (b + d)
Where: a = Max labor demand, b = Demand sensitivity, c = Min labor supply, d = Supply sensitivity.
Equilibrium Labor Market Calculator
Enter the parameters for the Labor Demand and Labor Supply curves to find the market equilibrium.
Step-by-Step Calculation Guide
To calculate the equilibrium real wage rate manually, follow these four steps:
- Define the Demand Function: Determine how many workers firms will hire at different real wage levels. Usually, as the real wage increases, demand decreases.
- Define the Supply Function: Determine how many workers are willing to work at different real wage levels. Usually, as the real wage increases, supply increases.
- Set Demand Equal to Supply: Equate the two functions (LD = LS).
- Solve for (W/P): Use algebraic isolation to find the value of the real wage that balances the equation.
Example Calculation
Suppose a local economy has the following labor dynamics:
| Variable | Equation/Value |
|---|---|
| Labor Demand (LD) | 500 – 20(W/P) |
| Labor Supply (LS) | 100 + 30(W/P) |
| Set Equal | 500 – 20(W/P) = 100 + 30(W/P) |
| Group Terms | 400 = 50(W/P) |
| Equilibrium Real Wage | 8.00 units |
Factors That Shift Equilibrium
The equilibrium real wage is not static. It shifts based on several economic factors:
- Labor Productivity: If workers become more productive (due to technology or training), the Labor Demand curve shifts right, increasing the equilibrium real wage.
- Population Changes: An increase in the working-age population shifts the Labor Supply curve right, which typically lowers the equilibrium real wage but increases total employment.
- Cost of Living (Price Level): Since the "Real Wage" is Nominal Wage / Price Level, a sudden spike in inflation (Price Level) decreases the real wage unless nominal wages are adjusted upwards.