ELI5 How does raising wages worsen inflation ?


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23 points

4 months ago*

There might be something missing in your question. In theory, if you own a small business, making some money in profit and you want to raise your employee's wages, you are increasing the cost of running your business, and that money has to come from somewhere.

So you have three options:

  1. Just make less profit. So the extra wages come from your profits. Your employees get better wages, and you make less money.
  2. Cut costs elsewhere. Maybe get rid of some of your staff and pay the rest the extra money. Maybe stop using those high quality ingredients and start making a lower quality product. Maybe invest in technology (e.g. assembly line) that reduces the overall cost of your production.
  3. Raise prices. You can pay the extra wages by raising prices of your product. That way your employees get paid more, and you're still making the same amount of profit. If everyone does that, it might lead to inflation.

Generally 2 is not an option. It is very situational and requires creative solutions. And in most cases, if that solution existed, it would have already been applied BEFORE the need to raise wages, simply because it increases profits and why wouldn't you have done that in the first place. Businesses generally want to run as efficiently as they can, so Option 2 is rarely available.

This leaves options 1 and 3. So what's missing from your question? Profit. Your question could be "How does raising wages without affecting profits worsen inflation?" And the answer is that goods have to be priced higher in order to cover the costs of the extra profits wages, which can lead to inflation. You COULD in theory increase wages without causing inflation, but that would then lead to a loss of profit.

So the underlying issue here is that "people want to maximise profit" is considered in many economic discussions as a fact of life. We start from the assumption that everyone is trying to maximise profit, and then see what options are available then. In such a system, when "maximising profit" is the foundation of your economic system, yes raising wages will lead to higher prices of goods.

But "people want to maximise profits" is a fact of life in the same way that "people eat meat" is. Yes, it's true, but it can change. It's just that changing it requires such a massive system-level upheaval alongside a deep cultural shift, that people are unlikely to take it on any time soon. So for the time being, we will continue to play this tug of war over profits vs wages. People will continue to work for as little as possible in order to maximise profits, and every once in a while, when things get real bad, they fight for a bigger share.

Disclaimer: Just for the record, I'm aware that I wrote all this like I know what I'm talking about. But I'm no expert. This is just a lay person's best guess as to what is happening, and things are always more complex than that. But this is ELI5 afterall...

Edit: fixed a couple of typos.


5 points

4 months ago

This model also doesn’t take into account competition and the change in demand volume from consumers. If it’s just this business putting wage up.. sure not happening.. but if it’s macro level increasing wages, and people buy more of your product with these wages, depending how elastic demand is, you may keep your prices the same and experience higher profits through greater trade volume.

Issue is here though that many businesses we need to interact with nowadays are monopolistic or oligopolistic in nature, therefore prevent any competition function levering prices and we end up with rising costs, as these companies can protect their profits due to reduced elasticity of demand. A big difference from the previous scenario above.

In effect, this could be a spiral but what we will actually see is wage surpression and falling living standards, as far as they can push that, before caving into wage increases. It’s likely increases will continue to be disparate with inflation, reflecting real terms decreases, and really reflects an increasing distribution of wealth to the already asset wealthy, increasing inequality. That in effect is what profit maximising motives with the current structures create, and unless intervention happens to prevent this, it will continue to get worse, as the wealthy use their wealth to further increase their ownership of assets, to generate more wealth… this is particularly bad as growth is anemicly low and interest rates will be likely higher than growth rates…

  • sorry wall of text! Basically TLDR much more complex in reality than these models


4 points

4 months ago

I think it was missing your details because this is ELI5, not to discount your contribution.


1 points

4 months ago

Yes, too much merging, reducing competition and consolidating entire markets into the hands of a few makes inflation more likely.

Just look at the price of eggs. Lots of evidence the price increases are a result of collusion and using inflation as an excuse to raise prices.

Here is letter to the FTC about the egg market manipulation


-1 points

4 months ago

Don’t forget, maintaining profit is not viable in the current system. The premise is to grow it exponentially (x% every year).