2. Labor market Suppose that the firm\'s markup over costs is 10% and that the w

Question

2. Labor market Suppose that the firm's markup over costs is 10% and that the wage setting equation is where W is the nominal wage, z is a positive coefficient representing all the other variables that affect positively the outcome of wage setting, P is the price level (the price is constant) and u the unemployment rate (all the percentage are converted into decimal in the equations a. Use the price setting equation to calculate the real wage real wage = b. Calculate the corresponding natural rate of unemployment (as a percentage) assuming that z is initially equal to 1 u-= c. Assume that as a result of an institutional change towards more generous unemployment benefits, z increases by 2%, calculate the real wage and the natural rate of unemployment (as a percentage real wage = d wov the effect of the increase in z on the labor market graph below using the PS and the WS curves. (Name all the relevant axes and curves)

Explanation / Answer

a. The price setting equation is

P/W = 1+

Rearranging we get the real wage equation as given below

W/P = 1/(1+)

where P is price level ,W is the nominal wage, markup over cost

b. to find natural rate of umemployment

W= P(z-2u)

Rearranging we get W/P = z-2u

We already know W/P = 1/(1+) Hence equating both

we get z-2u = 1/(1+)

Substituting the values for z =1 we get 1-2u = 1/(1+.10) = 0.909

Our aim is to find u , further solving we get 1-2u = 0.909 hence u =0.0455 which means the unemplyment percentage is 4.55%

c.Assuming z increases by 2% ,

we already have  z-2u = 1/(1+)

Substitute the appropriate values in the above equation to get u

ie. 1.02-2u=1/(1+.1) = 1/1.1 = 0.909 --> u = 0.055 or 5.55 % is natural rate of unemployment

Real wage = 1/(1+) = 0.909

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