1. Until fairly recently it was generally accepted that if wages are raised, profits decline in proportion. Even though in the analysis of other phenomena Say's Law was not adhered to, at least not strictly, in this case the preservation of purchasing power was not put in doubt. And the analysis of the increase or reduction in wage rates dealt with the physical consequences of this absolute shift from profits to wages, or vice versa. In the case of the rise in wage rates, the reconstruction of capital equipment in line with the higher spending on wage goods and lower outlays on investment and capitalist consumption was emphasized, as well as the tendency to higher unemployment as a result of substitution of capital for labour that has become more expensive.
Although even today quite a number of economists would argue in this fashion, the fallacy of this approach is fairly widely recognized, even though it may be countered by various economists in a somewhat different way. My counter-argument runs as follows. I assume a closed economic system and a proportional rise in all wage rates.
Suppose that in a short period of time the annual wage bill increased as a result of raising wage rates by ΔW. We may realistically assume that workers spend all their incomes, and that they spend them immediately. By contrast, it may be assumed that the volume of investment and capitalist consumption are determined by decisions taken prior to the short period considered, and are not affected by the wage rise during that period.
If we now subdivide the economy into three departments, producing investment goods (I), consumption goods for capitalists (II), and wage goods (III)--including in each of them the respective intermediate products--it follows that employment in the first two departments is not affected by the rise in wages. Thus, denoting the wage bills in these departments measured in 'old' wage rates by W1 and W2 and the fraction by which wages are raised by α, we obtain for the increment of the aggregate wages in Departments I and II α(W1 + W2). The profits in these two departments decline propor