Wage Hikes as Supply and Demand Shock

Wage hikes affect production costs and hence are usually analysed as supply shocks. There is, however, a long-standing debate about demand effects of wage variations. In this paper, we bring together these two arguments in a Kaldorian model with group specific saving rates and a production technology that allows for redistribution between workers and entrepreneurs following a wage hike. We thereby pinpoint the conditions under which a) wage variations affect aggregate demand, and b) the positive demand effects of wage hikes may even overcompensate the negative supply effects on aggregate employment (“purchasing power argument”). We conclude by noting that whereas demand effects are very likely to occur, the conditions under which the purchasing power argument does indeed hold are very unrealistic. JEL classification: E23; J23; J5