Summary Macroeconomics
Ratio of unemployment
o
Why is there unemployment?
o (unemployment can be frictional or cyclical)
o The wages cannot adjust quick to the supply/demand of labor, this is called WAGE
INFLEXIBILITY.
Wage inflexibility is caused by mainly two factors:
Collective bargaining:
o Wages are set after bargaining between firms and labor
unions. They both have market power.
Labor market institutions:
o Labor market institutions cause workers to have a
reservation wage before accepting a job.
o Examples are:
Unemployment benefits
Unemployment insurance
Minimum wage laws
Wage determination
o Bargaining power:
The power of the labor unions to ask for a higher wage
o Reservation wage:
The wage for which unemployed people are indifferent between working
and not working.
o Unemployment rate:
The higher the unemployment rate, the lower the salaries. Higher supply
means lower price. Lowering the unemployment cause a raise in the wages.
Wage setting
o Wages are determined by the following formula: W = P e F(u, z)
W = Wages
Pe = Expected price level
u = The unemployment rate (-)
z = “Catch all” variable, such as labor market institutions (+)
Real wage and expected price
o Nobody cares about nominal wages (W), but do care about real wages (W/P).
Workers care about how many goods can be bought with their wages (W/P).
Firms care about the wage they pay in relation to the price of the goods they
sell (W/P).
o But why expected prices?
Because prices are unknown when the wages are set!!
Price determination
o Firms produce goods according to their production function:
o Y = AN
o A = technology
o N = Employment
, Implication: the marginal costs of production are equal to W.
o Firms set their prices according the following formula : P = (1+M)W
o Real wages is = W/P = 1 / (1+M) (ONLY IF THE NATURAL RATE OF UNEMPLOYMENT
IS EQUAL TO THE CURRENT RATE OF UNEMPLOYMENT) (EXPECTED INFLATION IS
EQUAL TO CURRENT INFLATION)
M= mark-up (the degree of power that a firm has in a certain market)
Labor market equilibrium
o Graphically represented by the WS-PS curve
Shifts of the curves
o An increase in the unemployment benefits will increase the wages (upside shift of
the WS). A higher unemployment rate is needed to bring back the real wages that
firms will pay. This due to the reservation wage.
So far:
o The unemployment rate is determined by the price-setting and the wage-setting of
firms.
o When prices are equal to expected prices, we find the natural rate of
unemployment.
Phillips Curve
o
o = Inflation
o = Expected inflation
o = Mark-up
o = “Catch all” variable
o = Alpha times unemployment
Expected inflation
o
Ratio of unemployment
o
Why is there unemployment?
o (unemployment can be frictional or cyclical)
o The wages cannot adjust quick to the supply/demand of labor, this is called WAGE
INFLEXIBILITY.
Wage inflexibility is caused by mainly two factors:
Collective bargaining:
o Wages are set after bargaining between firms and labor
unions. They both have market power.
Labor market institutions:
o Labor market institutions cause workers to have a
reservation wage before accepting a job.
o Examples are:
Unemployment benefits
Unemployment insurance
Minimum wage laws
Wage determination
o Bargaining power:
The power of the labor unions to ask for a higher wage
o Reservation wage:
The wage for which unemployed people are indifferent between working
and not working.
o Unemployment rate:
The higher the unemployment rate, the lower the salaries. Higher supply
means lower price. Lowering the unemployment cause a raise in the wages.
Wage setting
o Wages are determined by the following formula: W = P e F(u, z)
W = Wages
Pe = Expected price level
u = The unemployment rate (-)
z = “Catch all” variable, such as labor market institutions (+)
Real wage and expected price
o Nobody cares about nominal wages (W), but do care about real wages (W/P).
Workers care about how many goods can be bought with their wages (W/P).
Firms care about the wage they pay in relation to the price of the goods they
sell (W/P).
o But why expected prices?
Because prices are unknown when the wages are set!!
Price determination
o Firms produce goods according to their production function:
o Y = AN
o A = technology
o N = Employment
, Implication: the marginal costs of production are equal to W.
o Firms set their prices according the following formula : P = (1+M)W
o Real wages is = W/P = 1 / (1+M) (ONLY IF THE NATURAL RATE OF UNEMPLOYMENT
IS EQUAL TO THE CURRENT RATE OF UNEMPLOYMENT) (EXPECTED INFLATION IS
EQUAL TO CURRENT INFLATION)
M= mark-up (the degree of power that a firm has in a certain market)
Labor market equilibrium
o Graphically represented by the WS-PS curve
Shifts of the curves
o An increase in the unemployment benefits will increase the wages (upside shift of
the WS). A higher unemployment rate is needed to bring back the real wages that
firms will pay. This due to the reservation wage.
So far:
o The unemployment rate is determined by the price-setting and the wage-setting of
firms.
o When prices are equal to expected prices, we find the natural rate of
unemployment.
Phillips Curve
o
o = Inflation
o = Expected inflation
o = Mark-up
o = “Catch all” variable
o = Alpha times unemployment
Expected inflation
o
