Economics, 3rd Edition

Real Wage Flexibility 

Suppose there is a high degree of wage flexibility in each of the member  countries, 

so that wages respond strongly to rises and falls in unemployment. This means that the adjustment to 

long-run equilibrium, as shown in Figure 36.1, occurs very quickly. In our example, the shift in aggregate 

demand in Germany leads to falling wages, so that firms make more profit for any given level of prices and 

the aggregate supply curve shifts to the right and Germany returns to the natural rate of output. If wages 

are very flexible, this adjustment may be very rapid, so that the short run is very short indeed. Similar 

for France: the rightwards shift in aggregate demand leads to rapidly rising wages and firms find it less 

profitable to produce any given level of output, so that the supply curve shifts leftwards and a new long-

run equilibrium is established at the natural rate of output. Hence, by compressing the short run, tensions 

across the monetary union are ironed out very quickly.

Note that it is the real wage that is of importance here: it is real wages that must adjust in order to 

affect the aggregate supply curve by making it more (or less) profitable for firms to produce a given level 

of output at any given level of prices.