Eco’s textbook notes:
UNIT 9:
9.1 The wage-setting curve, the price-setting curve & the labour market
Profits are determined by just three things: the nominal wage (the actual amount received
in a particular currency), the price at which the firm sells its goods, and the average output
produced by a worker in an hour.
The wage-setting curve: The curve that gives the real wage necessary at each level of
economy-wide employment to provide workers with incentives to work hard and well.
The price-setting curve: This gives the real wage paid when firms choose their profit-
maximizing price
9.2 Measuring the economy: Employment & Unemployment
9.3 The wage setting curve: employment and real wages
9.4 The firm’s hiring decision
Mark-up is greater when the demand is less elastic (less intense competition)
9.5 The Price-setting curve: Wages and Profits in the whole economy
Average product of labour =
firms’ revenue per worker in
real terms
Price setting curve= the value
of the real wage that is
consistent with the mark-up
over costs, when all firms set
their price to maximize their
profits
,2 main influences on the price-setting curve:
- Competition: The less competition, the higher the mark-up. A steeper demand curve
means less competition amongst firms and increase in the profits per worker. This
leads to higher prices for the entire economy which implies lower wages. Therefore,
pushing the wage setting curve down.
- Labour productivity: For any mark-up the amount a worker produces in an hour
determines the real wage. Higher productivity = higher wage. In the figure below,
Higher productivity shifts the dashed line upwards and the mark-up is unchanged.
The price setting curve will shift upwards, raising the real wage.
,9.6 Wages, profits and unemployment in the whole economy
Labour market equilibrium= where the price-setting curve and wage-setting curve intersect.
Point X = NE (mutual best response)
Equilibrium unemployment = The number of people seeking work but without jobs, which is
determined by the intersection of the wage-setting and price-setting curves. This is the Nash
equilibrium of the labour market where neither employers nor workers could do better by
changing their behaviour.
On the price setting curve, employment is the highest it can be, given the offered wage.
Unemployment as a characteristic of the labour market:
- There will always be unemployment in labour market equilibrium.
- If there was no unemployment: The cost of job loss is zero (no employment rent)
because a worker who loses her job can immediately get another one at the same
pay.
- Therefore, some unemployment is necessary: The employer can motivate workers to
provide effort on the job.
- The wage-setting curve is always to the left of the labour supply curve.
- It follows that in any equilibrium, where the wage and price-setting curves intersect,
there must be unemployed people: This is shown by the gap between the wage-
setting curve and the labour supply curve.
, 9.7 How changes in demand for goods affect unemployment:
“Derived demand labour” highlights that the firms demand for labour depends on the
demand for their goods or service
Aggregate demand= the sum of the demand for all of the goods and services produced in
the economy, whether from consumers, firms, the government, or buyers in other
countries.
*recession can be caused by a fall in aggregate demand (business produces less, therefore
needs less workers, people lose their jobs)
Cyclic unemployment/ demand-deficient unemployment = The increase in unemployment
above equilibrium unemployment caused by a fall in aggregate demand associated with the
business cycle.
Movement from X to B is because demand for product decreases.
At point B there are additional people looking for jobs (who are also involuntarily
unemployed) owing to low aggregate demand. The total involuntary unemployment is given
by the sum of cyclic and equilibrium unemployment.
Point X = Equilibrium unemployment (NE)
At point B there is high unemployment so HR can lower wages because people are still
willing to work as hard.
HR sequence:
• Lower wages would lower costs.
• The competition has not changed, so it would want to set a price to restore the profit-
maximizing mark-up.
• Given the lower costs, firms would’ve cut prices.
, • Because the demand curve facing the firm is downward-sloping they would sell more,
expanding output and employment.
• In the long run we would move back to point X (diagram above)
The new (lower wage) isoprofit curve passing through the original point B is now steeper
than the demand curve, so the firm can do better by lowering its price and moving down the
demand curve, selling more.
It will continue doing this until it reaches a point on the demand curve where one of the
new darker blue isoprofit curves is tangent to the demand curve.
The firm maximizes profits at point X.
Things that could go wrong in a real economy:
1. Worker resistance to a cut in nominal wage:
- Reduce employee morale
- Create conflict
- Strikes (e.g. go-slow)
2. Wage + Price reduction may not lead to higher sales + employment:
- For individual firms a fall in price could lead to higher sales but across the entire
economy it can lead to cutbacks in spending
- Households could postpone spending in hopes for better bargains later
- As wages fall, spending decreases and the demand falls
UNIT 9:
9.1 The wage-setting curve, the price-setting curve & the labour market
Profits are determined by just three things: the nominal wage (the actual amount received
in a particular currency), the price at which the firm sells its goods, and the average output
produced by a worker in an hour.
The wage-setting curve: The curve that gives the real wage necessary at each level of
economy-wide employment to provide workers with incentives to work hard and well.
The price-setting curve: This gives the real wage paid when firms choose their profit-
maximizing price
9.2 Measuring the economy: Employment & Unemployment
9.3 The wage setting curve: employment and real wages
9.4 The firm’s hiring decision
Mark-up is greater when the demand is less elastic (less intense competition)
9.5 The Price-setting curve: Wages and Profits in the whole economy
Average product of labour =
firms’ revenue per worker in
real terms
Price setting curve= the value
of the real wage that is
consistent with the mark-up
over costs, when all firms set
their price to maximize their
profits
,2 main influences on the price-setting curve:
- Competition: The less competition, the higher the mark-up. A steeper demand curve
means less competition amongst firms and increase in the profits per worker. This
leads to higher prices for the entire economy which implies lower wages. Therefore,
pushing the wage setting curve down.
- Labour productivity: For any mark-up the amount a worker produces in an hour
determines the real wage. Higher productivity = higher wage. In the figure below,
Higher productivity shifts the dashed line upwards and the mark-up is unchanged.
The price setting curve will shift upwards, raising the real wage.
,9.6 Wages, profits and unemployment in the whole economy
Labour market equilibrium= where the price-setting curve and wage-setting curve intersect.
Point X = NE (mutual best response)
Equilibrium unemployment = The number of people seeking work but without jobs, which is
determined by the intersection of the wage-setting and price-setting curves. This is the Nash
equilibrium of the labour market where neither employers nor workers could do better by
changing their behaviour.
On the price setting curve, employment is the highest it can be, given the offered wage.
Unemployment as a characteristic of the labour market:
- There will always be unemployment in labour market equilibrium.
- If there was no unemployment: The cost of job loss is zero (no employment rent)
because a worker who loses her job can immediately get another one at the same
pay.
- Therefore, some unemployment is necessary: The employer can motivate workers to
provide effort on the job.
- The wage-setting curve is always to the left of the labour supply curve.
- It follows that in any equilibrium, where the wage and price-setting curves intersect,
there must be unemployed people: This is shown by the gap between the wage-
setting curve and the labour supply curve.
, 9.7 How changes in demand for goods affect unemployment:
“Derived demand labour” highlights that the firms demand for labour depends on the
demand for their goods or service
Aggregate demand= the sum of the demand for all of the goods and services produced in
the economy, whether from consumers, firms, the government, or buyers in other
countries.
*recession can be caused by a fall in aggregate demand (business produces less, therefore
needs less workers, people lose their jobs)
Cyclic unemployment/ demand-deficient unemployment = The increase in unemployment
above equilibrium unemployment caused by a fall in aggregate demand associated with the
business cycle.
Movement from X to B is because demand for product decreases.
At point B there are additional people looking for jobs (who are also involuntarily
unemployed) owing to low aggregate demand. The total involuntary unemployment is given
by the sum of cyclic and equilibrium unemployment.
Point X = Equilibrium unemployment (NE)
At point B there is high unemployment so HR can lower wages because people are still
willing to work as hard.
HR sequence:
• Lower wages would lower costs.
• The competition has not changed, so it would want to set a price to restore the profit-
maximizing mark-up.
• Given the lower costs, firms would’ve cut prices.
, • Because the demand curve facing the firm is downward-sloping they would sell more,
expanding output and employment.
• In the long run we would move back to point X (diagram above)
The new (lower wage) isoprofit curve passing through the original point B is now steeper
than the demand curve, so the firm can do better by lowering its price and moving down the
demand curve, selling more.
It will continue doing this until it reaches a point on the demand curve where one of the
new darker blue isoprofit curves is tangent to the demand curve.
The firm maximizes profits at point X.
Things that could go wrong in a real economy:
1. Worker resistance to a cut in nominal wage:
- Reduce employee morale
- Create conflict
- Strikes (e.g. go-slow)
2. Wage + Price reduction may not lead to higher sales + employment:
- For individual firms a fall in price could lead to higher sales but across the entire
economy it can lead to cutbacks in spending
- Households could postpone spending in hopes for better bargains later
- As wages fall, spending decreases and the demand falls
