Question

3. Use the Wage-Setting (WS) and Price-Setting (PS) relations to examine the effects of the following events on the natural rate of unemployment, real wage, level of employment, and output.

a. reduction in employment insurance.

b. less stringent competition law.

c. increase in the minimum wage.

Answer 1

3.

Ans:

We have:

Wage setting relation:

where,

Real wage in decreasing in unemployment rate(u) and increasing in catchall variable(z) covering things like unemployment insurance.

Price setting relation:

where,

Real wage is decreasing in markup set by firms.

a.

Reduction unemployment insurance causes z to fall due to which real wage falls (WS shifts down). This causes unemployment rate to fall(as unemployment benefits have reduced), and employment and output to rise.

b.

Less stringent competition law implies that market will tend to become less competitive which will increase markup(PS shifts down). This will cause fall in real wage to fall, unemployment to rise, employment and output to fall.

c.

Increase in minimum wage(assuming binding) will cause rise in z (WS will shift up). This will cause unemployment to rise, employment and output to fall.

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