Question

There is high demand for labor but the supply of labor is not enough, so creating a labor shortage and salaries are going up. Question: why are wages rising so fast? What might be some of the consequences of a lengthy period of rapid wage inflation in China

Answer 1

The wages are rising so fast in the economy because of labor shortage in the economy.A shortage of labor in the economy will lead to increase in the level of wage to bring the labor market back to its equilibrium wage rate where labor demanded is equal to labor supplied of the economy. This can be depicted in the following graph as follows:

In the labor market diagram above, at the prevailing wage rate level in the economy at w1, the labor demanded exceeds the labor supplied by AB amount. This has led to disequilibrium in the market for labor. To bring the labor market back to its equilibrium level, the wage rate in the economy should rise to w*, where the demand and supply intersects and labor demanded will fall and labor supplied will rise and will lead to labor market equilibrium at w*.Thus, labor shortage in the economy leads to wages rising so fast in the economy.

A lengthy period of rapid wage inflation in the economy will lead to rise in aggregate demand in the economy because of rise in the consumption expenditure and this will shift the aggregate demand of the economy rightwards leading to rise in the inflation rate in the economy. Thus, a lengthy period of rapid wage inflation in China might lead to rising price level in the economy.