3. Consider the labor market represented by the wage-setting and the price-setti

Question

3. Consider the labor market represented by the wage-setting and the price-setting relations, which is shown below. Answer the following three questions Real wage, W/P Price-setting relation PS 1 + m Wage-setting relation WS Un Unemployment rate, u Suppose the unemployment rate is very low. How does the low unemployment rate change the relative bargaining power of workers and firms? What do your answers imply about the behavior of the real wage when the unemployment rate is very low? a. Hints: If unemployment is very low (expansions), workers have more possibilities of finding a job because firms are willing to hire more workers. In order to avoid an increase in quits, firms are willing to pay higher wages to induce workers to stay with them (efficiency wage theories) Alternatively, a low unemployment rate increases the relative bargaining power of workers, which allows them to demand higher wages (collective bargaining theories) Therefore, there is a negative relation between unemployment and real wages, reflected by the downward-sloping wage-setting relation What will happen to the labor market if the government extends the length of time workers could receive unemployment benefits? Illustrate your answer in the diagram above Hints: An increase in the length of time that workers can receive unemployment benefits is captured by an increase in z. This will shift up the wage-setting equation Why? Show the final effect on the un using the diagram for the labor market, and explain the logic behind your answer b. What will happen to the labor market if the mark-up of prices over unitary costs is reduced? Hints: A reduction in the mark-up is captured by a reduction in m. This will shift up the price-setting equation. Show the final effect on the un using the diagram for the labor market, and explain the logic behind your answer C.

Explanation / Answer

a) When the unemployment rate is very low, it leads to higher real wages.

Low unemployment rate leads to more employed people resulting in lesser unemployed available mapower in the market. Now, this may result in lesser choices of the employer to replace exisiting people.

The bargaining power of the firm decreases but for the worker it increases.

b) If the length of time for unemplyment benefit is increased by government, t may lead to more unemployment due to the availability and capability of scope of the employees to affors to get unemployed by accepting government benefits.

This will help the employees to be unemployed forlonger time frame that may lead to lesser friction in labour market but more unemployment and more bargaining power for the employer and lesser for the employees.

c) If mark-up prices increase, the unemployment would reduce and that would result in more real wage, means more bargaining power for the employees due to lesser unemployment and lesser bargaining power for employer.

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