Inflation means a fall in purchasing power. The same £1 no longer carries the same value as before the oil price hike. To make it simple, now you buy lesser good with the same £1. Hence with an increase at least can compensate for the decreasing purchasing power
- To maintain economic momentum. GDP is largely associated with consumer spending (C). In most cases, C is the largest component of AD (aggregate demand). With an increase in wages, people are able to continue their consumption pattern as before. This could have a knock on effect onto other areas in the economy e.g. firms are able to remain profitable. As such, they may have more money for reinvestment (I) into their business & this could in turn affect AD & thus further economic growth
- To certain extent, it may increase productivity of employee. People seeing an increase in their paycheck will be more motivated to work. As a result, output will increase & this will help to lower down the costs of production due to a larger spread of costs over a greater number of outputs
- Lower down unemployment in the economy. How? As the gap between unemployment benefits (UK) & wages by working increase, people will soon realise that the opportunity costs of staying unemployed gets larger. Hence this will push more of those unemployed people into the labour market
1. It may not even compensate for the fall in purchasing power, if the increment is not justified or insignificant. Example if costs of living overall increase by 15%, but the hike in salary is just 4%, then it may not help to ease the burden of those low-paid employees by much although one could argue that it is better than nothing
2. An increase in paycheck means an increase in the costs of production to firms. As a result the final goods being sold will be priced higher so as to maintain the company’s profitability. Seeing this, employees will soon realised that they are being priced out & they will demand another round of increase in pay. So, again the final goods being produced will be even more expensive. This cycle will repeat itself & it’s called WAGE-SPIRAL inflation. Situation could be worse if we factor in possible increase of oil price to USD$ 200 per barrel this year
3. Workers will still be worse off! How? Under the progressive tax system, an increase in paycheck means falling into higher income bracket. Say if inflation increase by 4% & a person’s nominal income increase by 4%, his real income remain unchanged. But as his nominal income is higher, he will be subjected to higher tax. So overall the employee is worse off. Furthermore it is unlikely, that our paycheck increase at the rate of inflation. Likely, it could be lower!
4. Higher pay could also mean greater extent of unemployment in the economy! Firms will attempt to cut their costs of production & the normal measure being undertaken is retrenchment although one could argue that they can cut their costs elsewhere