Download The short run relationship between unemployment (U)

So far we understood how the goods and money market interact
using the IS-LM model by assuming fixed prices.
We also understood price determination using the Aggregate
demand-Aggregate supply model.
Now we will study further the labor market…
Topic
III. MACROECOMIC EQUILIBRIUM IN A FIXED PRICE MODEL:
SORT-RUN ANALYSIS
A. The goods market
B. The money market
C. The goods and money markets together (The IS-LM model)
IV. MACROECOMIC EQUILIBRIUM IN A FLEXIBLE PRICE
MODEL: LONG-RUN ANALYSIS
A. Determination of the price level (The AS-AD model)
B. Labor Market
Textbook
chapters
8, 8A, 9, 9A
10, 11
12
13
14
•
Basic concepts
- Labor demand and supply curve
•
Classical view of Labor market
- The classical view and the AS
- The classical view and the unemployment rate
•
Explaining the existence of unemployment
- Sticky wages
- Efficiency wages
- Imperfect Information
- Minimum wage laws
•
The short run relationship between unemployment (U) and inflation (π)
- Short-run relationship between output (Y) and unemployment (U)
- Short-run relationship between output (Y) and inflation (π)
- Phillips Curve: Short-run relationship between inflation (π) and unemployment (U)
•
The Phillips curve: A historical perspective
- 1960-1969 vs. 1970-2004
- How could we rationalize the unstable Phillips curve?
•
The long run relationship between unemployment (U) and inflation (π)
•
The nonaccelerating inflation rate of unemployment (NAIRU)
Basic concepts
- Labor demand and supply curve
Labor supply curve:
A graph that illustrates the amount of labor that
households want to supply at each given wage rate.
Labor demand curve:
A graph that illustrates the amount of labor that firms
want to employ at each given wage rate.
Classical view of Labor market
- The classical view and the AS
•
The classical idea that wages adjust to clear the labor market is consistent with
the view that wages respond quickly to price changes. This means that the AS
curve is vertical.
•
When the AS curve is vertical, monetary and fiscal policy cannot affect the level
of output and employment in the economy.
- The classical view and the unemployment rate
How to reconcile high levels of unemployment with the idea of
optimal behavior of firms and workers?
1) The unemployment rate is not necessarily an accurate indicator of
whether the labor market is working properly. Rational behavior.
2) The measured unemployment rate may sometimes seem high even
though the labor market is working well. For example under high
mobility across firms.
Great depression
=
Great Vacation!!
Explaining the existence of unemployment
- Sticky wages
The downward rigidity of wages as an explanation for the existence of
unemployment.
- Social, or implicit, contracts
- Relative-wage explanation of
unemployment
If workers are concerned about
their wages relative to other
workers in other firms and
industries, they may be unwilling
to accept a wage cut unless they
know that all other workers are
receiving similar cuts.
- Explicit Contracts
- Efficiency wages
An explanation for unemployment that holds that the productivity of
workers increases with the wage rate. If this is so, firms may have
an incentive to pay wages above the market-clearing rate.
Equilibrium with
efficiency wages
Equilibrium without
efficiency wages
- Imperfect Information
Firms may not have enough information at their disposal to know what
the market-clearing wage is. In this case, firms are said to have imperfect
information.
If firms have imperfect or incomplete information, they may set wages
wrong—wages that do not clear the labor market.
- Minimum wage laws
Laws that set a floor for wage rates - that is, a minimum hourly rate for
any kind of labor. If the minimum wage is higher than the equilibrium
wage without any type of intervention there will exist unemployment.
The short run relationship between
unemployment (U) and inflation (π)
- Short-run relationship between output (Y)
and unemployment (U)
Negative relationship:
Y
↑Y  ↑L used  ↓U
U
- Short-run relationship between output (Y) and inflation (π)
If triggered by a shift in AD:
positive relationship between Y and π
If triggered by a shift in AS:
negative relationship between Y and π
If triggered by a shift in both AD and AS:
no systematic relationship between Y and π
- Phillips Curve: Short-run relationship between
inflation (π) and unemployment (U)
Depends on the short-run relationship between:
i) output (Y) and unemployment (U) (negative)
ii) output (Y) and inflation (π) (positive, negative, unrelated)
π
If triggered by a shift in AD:
negative relationship between
inflation (π) and unemployment (U)
π
U
If triggered by a shift in AS:
positive relationship between
inflation (π) and unemployment (U)
U
π
If triggered by a shift in both AD and AS:
no systematic relationship between
inflation (π) and unemployment (U)
U
The Phillips curve: A historical perspective
1960-1969
1970-2004
- How could we rationalize the unstable Phillips curve?
Oil crisis of 1970s:
Inflation expectations:
Expectations are self-fulfilling. This means that wage inflation
is affected by expectations of future price inflation.
Price expectations that affect wage contracts eventually affect
prices themselves.
Inflationary expectations shift the Phillips Curve to the right.
The long run relationship between
unemployment (U) and inflation (π)
π
.
U*
Potential GDP
U
Natural rate of unemployment:
The unemployment that occurs as a
normal part of the functioning of the
economy. Sometimes taken as the
sum of frictional unemployment and
structural unemployment.
The nonaccelerating inflation rate of
unemployment (NAIRU)
-1