I've been trying to wrap my head around the concept of the Ricardo Effect. From what I'm reading, the theory is that when real wages change, even though nominal wages remain unchanged, employers will be influenced by the change. For example, if a company has been paying an employee $10.00/hr. to do his job, and then comes a change in the structure of the economy, such that $10.00 will not buy the employee as many consumer goods as it used to, that somehow gives the employer more incentive to use labor, instead of machinery.
It would seem that the thing that would influence the employer's choice between using labor, as opposed to machinery would be how much the employer gets in return for his cost. Since nominal wages are unchanged, the employer is still paying $10.00/hr., and the employee is still doing the same work for his pay, where is the incentive to change anything?
Even Stephen
Hayek, F. A. (May 1942). "The Ricardo Effect." Economica.:
The proposition here described as the Ricardo Effect asserts that a general change in wages relatively to the prices of the products will alter the relative profitability of different industries or methods of production which employ labour and capital ("indirect labour") in different proportions. In its original form it asserts that a general rise in wages relatively to the prices of the products will reduce the profitability of the industries or methods employing relatively more capital to a lesser extent than those employing less capital.
An employer will chose to increase the proportion of capital to labor during a time of increased savings. A decrease in demand will cause a marginal decrease in prices. At this point, an entrepreneur is widening and lengthening the stages of production. Given an increase in the cost of labor in proportion to the prices of goods, it would make sense for an entrepreneur to exchange labor for capital-goods (machinery), since the latter is cheaper. The Ricardo Effect also holds that at the end of this period of investment, there will be an increase in demand for labor, as consumption increases and savings decrease (also, the production of these capital-goods will require labor).
Huerta de Soto, Jesús (2009). Money, Bank Credit and Economic Cycles. Auburn, Alabama: Ludwig von Mises Institute.:
All increases in voluntary saving exert a particularly important, immediate effect on the level of real wages. Chart V-2 shows how the monetary demand for consumer goods falls by one-fourth (from 100 m.u. to 75 m.u.), due to the rise in saving. Hence it is easy to understand why increases in saving are generally followed by decreases in the prices of final consumer goods.49 If, as generally occurs, the wages or rents of the original factor labor are initially held constant in nominal terms, a decline in the prices of final consumer goods will be followed by a rise in the real wages of workers employed in all stages of the productive structure. With the same money income in nominal terms, workers will be able to acquire a greater quantity and quality of final consumer goods and services at consumer goods’ new, more reduced prices.
This increase in real wages, which arises from the growth in voluntary saving, means that, relatively speaking, it is in the interest of entrepreneurs of all stages in the production process to replace labor with capital goods. To put it another way, via an increase in real wages, the rise in voluntary saving sets a trend throughout the economic system toward longer and more capital-intensive productive stages. In other words, entrepreneurs now find it more attractive to use, relatively speaking, more capital goods than labor. This constitutes a third powerful, additional effect tending toward the lengthening of the stages in the productive structure. It adds to and overlaps the other two effects mentioned previously.
when labour becomes cheaper relative to capital goods.then increase your utilization of the cheapening labour, and decrease your utilization of increasingly expensive capital goods and therefore you might make consumer goods at a lower cost.
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
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