Microeconomic theory tell us that wage rate is equal to marginal productivity of labor under conditions of labor market equilibrium between demand for labor and supply of labor. With no excess demand for or supply of labor, only productivity changes will cause changes in wage rate. Thus, when actual GDP is equal to potential GDP and so there is no GDP gap, the demand and supply of labor are equal. In such a situation wages will be at the same rate at which productivity is rising. Such a situation will leave the per unit wage cost unchanged. Thus, for example, there is a 5 per cent increase in productivity (i.e., the labor produces 5 per cent more output per unit of time) and also a 5 per cent increase in wage rate, then the average wage cost per unit of output remains unchanged.
When there is neither excess demand nor excess supply in the labor market, wage will tend to be rising at the same rate as labor productivity; as a result unit labor cost will remain constant.
With constant labor cost per unit of output, the position of the SRAS curve remains unaltered; it neither shifts up or down. So, there is no pressure on the price level to change. Thus, the absence of GDP or of actual output being equal to potential output is a situation of absence of any upward or demand pressure on the per unit cost and the price level.SUBMIT ASSIGNMENT NOW!