© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-1 Chapter Nineteen Wage Changes, Price Inflation and Unemployment Created by: Erica Morrill, M.Ed Fanshawe College

© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-2 Chapter Focus  The connection between aggregate wage changes and unemployment rate  The relationship between inflation and unemployment  Anti-inflationary policies  Persistence of unemployment  Wage rigidity

© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-3 Determinants of Wage Changes  Unemployment Rate  Expected Inflation  Unanticipated Inflation  Productivity Growth  Other Factors

© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-4 Unemployment Rate  Phillips Curve  negative relationship between unemployment and inflation rate.  Lipsey  unemployment is overall excess of demand or supply  rate of wage change is a function of this excess

© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-5 Figure 19.1 a Wage Changes, Excess Demand and Unemployment W N Disequilibrium in individual labour markets W N S S Wa*Wa* D D Wb*Wb* WaWa DaDa SaSa WbWb SbSb DbDb

© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-6 Figure 19.1 b Wage Changes, Excess Demand and Unemployment The relationship between wage changes and excess demand.Wi.Wi.Wa.Wa.W1b.W1b.Wb.Wb D i -S i S i D b -S b S b D a -S a S a

© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-7 Figure 19.1 c Wage Changes, Excess Demand and Unemployment U* V* U** V** The relationship between unemployment and job vacancies U V

© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-8 Figure 19.1 d Wage Changes, Excess Demand and Unemployment U* The relationship between aggregate excess demand and unemployment U D-S S

© 2002 McGraw-Hill Ryerson Ltd.Chapter 19-9 Figure 19.1 e Wage Changes, Excess Demand and Unemployment U* The relationship between wage changes and unemployment U. W

© 2002 McGraw-Hill Ryerson Ltd.Chapter Natural Unemployment  U* is independent of U  More than one unemployment rate at which the economy is in macroeconomic equilibrium  Increase in U* shifts the Phillips curve upward  larger wage increases at each rate  increased excess demand

© 2002 McGraw-Hill Ryerson Ltd.Chapter Explanation of the Phillips Curve  Two relationships  positive relationship between wage changes and excess demand  inverse relationship between excess demand and the unemployment rate

© 2002 McGraw-Hill Ryerson Ltd.Chapter Expected Inflation  Wages will adjust upward by the amount of the expected inflation  Supply and demand functions shift upward by the anticipated increase  Firm’s profits and workers’ utility depend on the real wage   in price level require an equal  in the nominal wage at each level of employment to maintain the real wage

© 2002 McGraw-Hill Ryerson Ltd.Chapter Figure 19.2 Wage Changes and Expected Inflation W N W N Wa*Wa* Wb*Wb* W a ** Na*Na* WbWb Na*Na* D(p 0 ) S(p 0 ) D(p e 1 ) S(p e 1 ) WaWa S(p 0 ) D(p 0 ) S(p e 1 ) D(p e 1 ) W b **

© 2002 McGraw-Hill Ryerson Ltd.Chapter Figure 19.3 Wage Changes, Unemployment, and Expected Inflation U* U. W 10 d. p e =10% a e 5 b. p e =5% c. p e =0

© 2002 McGraw-Hill Ryerson Ltd.Chapter Catch-Up for Unanticipated Inflation  Actual changes in price level may differ from the expected change  If inflation is greater employees will desire “catch-up” pay  If prices or other market wages are lower the employer will:  adjust wages downward  increase wages less quickly in the future

© 2002 McGraw-Hill Ryerson Ltd.Chapter Figure 19.4 Wage Changes and Unanticipated Inflation W N W0W0 D(p 1 e ) S(p 1 e ) W1*W1* W1aW1a D(p 1 a ) S(p a 1 ) S1aS1a D1aD1a

© 2002 McGraw-Hill Ryerson Ltd.Chapter Productivity Growth  Ultimate concern is real wage  Productivity growth influences wage negotiations  Offsetting factors  displacement effect  product demand effect  technical changes  Productivity gains may lower real wages

© 2002 McGraw-Hill Ryerson Ltd.Chapter Other Determinants of Money Wage Changes  Control for factors given the data set studied  Proxy for other variables which data was not available  rate of increase in wages in US  profits  changes in unionization  market imperfections  unusual events  public Policy

© 2002 McGraw-Hill Ryerson Ltd.Chapter Price Inflation and Unemployment  Wage changes influence prices through their effect on labour costs  Hold productivity growth and expected inflation constant  Price inflation and unemployment are inversely related

© 2002 McGraw-Hill Ryerson Ltd.Chapter p e =10% 5. p e =5% Figure 19.5 The Relationship between Inflation and Unemployment U* U. P a b. p e =0 g c e d f h

© 2002 McGraw-Hill Ryerson Ltd.Chapter Unemployment Persistence  Explanations for persistent unemployment include:  insider-outsider models of wage setting  the loss of physical or human capital during economic downturns  features of the unemployment insurance system

© 2002 McGraw-Hill Ryerson Ltd.Chapter Anti-Inflation Policy  Full Employment and Price Stability  Demand Restraint  Enhancing Credibility  Income Policies  Encouraging Wage and Price Flexibility

© 2002 McGraw-Hill Ryerson Ltd.Chapter End of Chapter Nineteen