Question

The natural rate of unemployment Suppose that the markup of the prices of products over wage...

The natural rate of unemployment

Suppose that the markup of the prices of products over wage

cost, z, is 10%, and that the wage-setting equation is

W = P*(1 - 2m + z)

where m is the unemployment rate and z is the unemployment

benefit/minimum wage.

a. What is the real wage, as determined by the price-setting

equation?

b. Solve for the natural rate of unemployment

c. What happens to the natural rate of unemployment if z

falls from 10% to 5%? Explain your answer.

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Answer #1

A. Real wage under price setting equation:

W/P=1/(1+z)= 1/(1+0.1)= 0.90

B. Natural rate of unemployment:

W/P=1-2m+z= 0.9

1-2m+0.1=0.9

1-0.8=2m

m=0.1

Natural rate of unemployment=0.1 or 10%

C. If z=0.05

1-2m+0.05=0.9

1-0.05-0.9=2m

0.05/2=m

0.025=m

Natural rate of unemployment =0.025 or 2.5%

When markup falls, natural rate of unemployment falls.

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