Lecture Labour market economics: Chapter 19 - Dwayne Benjamin, Morley Gunderson, Craig Riddell

Chapter 19 - Wage changes, price inflation and unemployment. This chapter presents the following content: The connection between aggregate wage changes and unemployment rate, the relationship between inflation and unemployment, anti-inflationary policies, persistence of unemployment, wage rigidity.

Chapter Nineteen Wage Changes, Price Inflation and Unemployment  Created by: Erica Morrill, M.Ed           Fanshawe College © 2002 McGraw­Hill Ryerson Ltd Chapter 19­1 Chapter Focus  The connection between aggregate wage changes and unemployment rate  The relationship between inflation and unemployment  Anti-inflationary policies  Persistence of unemployment  Wage rigidity © 2002 McGraw­Hill Ryerson Ltd Chapter 19­2 Determinants of Wage Changes  Unemployment Rate  Expected Inflation  Unanticipated Inflation  Productivity Growth  Other Factors © 2002 McGraw­Hill Ryerson Ltd Chapter 19­3 Unemployment Rate  Phillips Curve  negative relationship between unemployment and inflation rate  Lipsey  unemployment is overall excess of demand or supply  rate of wage change is a function of this excess © 2002 McGraw­Hill Ryerson Ltd Chapter 19­4 Wage Changes, Excess Demand and Unemployment Figure 19.1 a Disequilibrium in individual labour markets W W S S Wa Wb* Wa* Wb D D Da Sa N Sb Db N © 2002 McGraw­Hill Ryerson Ltd Chapter 19­5 Wage Changes, Excess Demand and Unemployment Figure 19.1 b he relationship between wage changes and excess demand Wi W Db-Sba Sb W1 b W Da-Sa Sa Di-Si Si b © 2002 McGraw­Hill Ryerson Ltd Chapter 19­6 Wage Changes, Excess Demand and Unemployment Figure 19.1 c The relationship between unemployment and job vacancie V V* V** U* U** U © 2002 McGraw­Hill Ryerson Ltd Chapter 19­7 Wage Changes, Excess Demand and Unemployment Figure 19.1 d D-S S The relationship between aggregate excess demand and unemployment U* U © 2002 McGraw­Hill Ryerson Ltd Chapter 19­8 Wage Changes, Excess Demand and Unemployment Figure 19.1 e The relationship between wage changes and unemployment W U* U © 2002 McGraw­Hill Ryerson Ltd Chapter 19­9 Natural Unemployment  U* is independent of U  More than one unemployment rate at which the economy is in macroeconomic equilibrium  Increase in U* shifts the Phillips curve upward  larger wage increases at each rate  increased excess demand Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 10 Explanation of the Phillips Curve  Two relationships  positive relationship between wage changes and excess demand  inverse relationship between excess demand and the unemployment rate Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 11 Expected Inflation Wages will adjust upward by the amount of the expected inflation  Supply and demand functions shift upward by the anticipated increase  Firm’s profits and workers’ utility depend on the real wage  in price level require an equal in the nominal wage at each level of employment to maintain the real wage  Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 12 Wage Changes and Expected Inflation Figure 19.2 S(pe1) S(p0) W S(pe1) W S(p0) Wb** Wa** Wa Wb* Wa* D(pe1) D(pe1)Wb D(p0) D(p0) Na* N Na* N Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 13 Figure 19.3 Wage Changes, Unemployment, and Expected Inflation W 10 d b c a e U* pe=10% pe=5% U pe=0 Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 14 Catch-Up for Unanticipated Inflation  Actual changes in price level may differ from the expected change  If inflation is greater employees will desire “catch-up” pay  If prices or other market wages are lower the employer will:  adjust wages downward  increase wages less quickly in the future Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 15 Wage Changes and Unanticipated Inflation Figure 19.4 S(pa1) W S(p1e) W1a W1* W0 D(p1a) D(p1e) S1a D1a N Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 16 Productivity Growth  Ultimate concern is real wage  Productivity growth influences wage negotiations  Offsetting factors  displacement effect  product demand effect  technical changes  Productivity gains may lower real wages Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 17 Other Determinants of Money Wage Changes Control for factors given the data set studied  Proxy for other variables which data was not available        rate of increase in wages in US profits changes in unionization market imperfections unusual events public Policy Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 18 Price Inflation and Unemployment  Wage changes influence prices through their effect on labour costs  Hold productivity growth and expected inflation constant  Price inflation and unemployment are inversely related Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 19 Figure 19.5 The Relationship between Inflation and Unemployment P e 10 b d c f a g h U* e p =10% e p =5% pe=0 U Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 20 Unemployment Persistence  Explanations for persistent unemployment include:  insider-outsider models of wage setting  the loss of physical or human capital during economic downturns  features of the unemployment insurance system Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 21 Anti-Inflation Policy  Full Employment and Price Stability  Demand Restraint  Enhancing Credibility  Income Policies  Encouraging Wage and Price Flexibility Chapter 19­ © 2002 McGraw­Hill Ryerson Ltd 22 End of Chapter Nineteen © 2002 McGraw-Hill Ryerson Ltd Chapter 19-23 ... © 2002 McGraw­Hill Ryerson Ltd Chapter 19 4 Wage Changes, Excess Demand and Unemployment Figure 19. 1 a Disequilibrium in individual labour markets W W S S Wa Wb* Wa* Wb D D Da Sa N Sb Db N © 2002 McGraw­Hill Ryerson Ltd Chapter 19 5... inversely related Chapter 19 © 2002 McGraw­Hill Ryerson Ltd 19 Figure 19. 5 The Relationship between Inflation and Unemployment P e 10 b d c f a g h U* e p =10% e p =5% pe=0 U Chapter 19 © 2002 McGraw­Hill Ryerson Ltd... © 2002 McGraw­Hill Ryerson Ltd Chapter 19 6 Wage Changes, Excess Demand and Unemployment Figure 19. 1 c The relationship between unemployment and job vacancie V V* V** U* U** U © 2002 McGraw­Hill Ryerson Ltd Chapter 19 7