Ratchet effect

The Ratchet Effect, also ratchet effect (English ratchet = pawl locking grid) is a term used in macroeconomic theory and refers to changes in the ratio of nominal wages to prices ( real wages ) in the Keynesian variant of the total models for the open and closed economy.

The Keynesian Total model is strong but not seen a total model, even if it deals with aggregate sizes, since the price level is not flexible there. However, the following statements are to apply for a Flex pricing model.

Assuming a price level income chart to to draw in the aggregate goods supply and goods demand functions, then the Keynesian variant of the goods supply function is characterized by a " kink" of which is located exactly where the equilibrium price level prevails, that is, where, by definition, full employment prevails in the labor market and the maximum equilibrium level of income is realized, in contrast to the Neoclassical goods supply function that runs price inelastic.

Conditions in the labor market

The aggregate supply of goods is realized by the equilibrium employment amount that was determined in the labor market ( and not automatic full employment, but merely an intersection of labor supply and labor demand curve ) is used in the production function. One can assume a Cobb- Douglas production function here, for example. The labor demand ( business ) address their demand from the real wage rate, as well as the work providers ( employees). The real wage is composed of nominal wage W and the price level P ( W / P). Both have understandably different preferences. The workers are assumed to be willing to offer more work at a higher real wage ( the increase in money for them assumed to be more attractive than the increase in leisure, they could achieve if they offer to higher wage less working time), while the labor demand of firms decreases, the higher the wages they have to pay.

Effect of a price level reduction

The difference between the neoclassical and Keynesian views in this model is that the nominal wage rate in underemployment case is rigid, both up and down. In practice, this would mean that the employees of a nominal wage reduction oppose, because the real wage would thus after a failure of the system, for example a price cut, go back. A price reduction namely leads to an increase in the real wage. The supply of labor is now increased, but decreased the demand for labor. The result is involuntary unemployment by an excess of supply in the labor market. This could be reduced by lowering the nominal wage. This, however, prevent the work provider.

Since a lower employment rate is realized, even less is produced and thus decreases the equilibrium level of income. We are located below the " kink " in the price-elastic region on the Ys curve. Here, the equilibrium level of income reacts to price level changes. Due to a price increase, the income can be increased to Y0 ultimately recoverable due to excess supply in the labor market is reduced thereby.

The ratchet effect

Above the " Knicks " on the other hand will continue the relationships of the neoclassical model are valid, ie towards the top of the nominal wage rate is to be flexible. Back to top so there is the Classical dichotomy of the system, that applies here: Price level changes pull equally large changes in nominal wage rate by itself, so that the real wage rate remains at the full-employment level unchanged. Changes in the nominal sizes so have no influence on the real sizes. Go down the nominal wage is rigid but still. Should it be so, starting coming from the full-employment level to a price increase, the nominal wage rises. Drop in the price but now that W is now rigid, ie with each price reduction goes back immediately the income. However, this means that the price elastic range, must have shifted with upwards. In the picture, the new award- elastic region is the upper diagonal. The lower diagonal is so meaningless, since it is no longer assumed to leave a once attained nominal wage level. The award- elastic region acts like a ratchet.

Recommended reading

• H.-W. Wohltmann " Broad macroeconomic theory ", 4th edition Oldenbourg Verlag 2005