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8/6/2019 Chapter 6 Part2 7(Whole) Nw
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MACROECONOMICS
Economics DepartmentXavier University- Ateneo de Cagayan
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Why are wages sticky?
Stickiness pertains to flexibility
Thus, wages are not flexible in ensuring full
employment.
The Phillips curve can be analyzed in another
angle (as a range of change in wages):
(u-u*) = (N*-N) / N*
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We can use the original Phillips curveequation and manipulate it into:
Gw - e = [ (Wt+1 Wt) / Wt ] -
e
= - (u-u*)
= - (N*-N) / N*Thus, at a certain level of unemployment, we
adjust the wages for the next period.
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Three cases:Gw -
e = - (N*-N) / N*
1. If N* > N ,
then Gw - e is (+), w high, emp lowleading to ( )
2. If N* > N ,
then Gw
- e is (-), w low, emp high
leading to (+)
3. If N* = N ,
then Gw - e is 0, no inflation;
At full employment
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Is inflation bad?
Yes and No.
Other issues:
1. Inflation means wages increase (Not alwaysright)
By imperfect information, we may not know the realw that will compensate the increasing cost of living.
2. Coordination problems Firms may adjust prices more when its all on demand,
but not on wages.
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PC to AS: Okuns law
3 steps:1. Translate output in terms of employment
2. Link prices to costs of adjusting
3. PC and WN relationship and combine
Okuns law
There is an inverse relationship betweenunemployment and GDP (by gaps).
(Y-Y*) / (Y*) = - (u-u*)
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PC to AS: Costs and Prices
I f we set the price, then there should be:
P = [(1+z) w] / a
Where:
z =mark up pricea= units of labor
w=cost of labor
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PC to AS: Costs and Prices
Pt+1 = (1+ e ) Pt [1 + (u-u*)]
= actual + expected
Where:
e = expected inflation
Pt = present pricesPt+1 = future prices
= responsiveness of unemployment gap withrespect to future prices
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What will happen to AD-AS
curve? Again with inflation, the AS curve will shift to
the left (if upward- sloping) and upward if AScurve is flat. (medium-run and short- run)
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Supply shocks
Adverse
If AS shifts up, an increase in prices
Example: oil shock 2 effects:
Assuming that we are in the medium run, the wehave a new equlibrium when the As shifts to the left,
given no change in AD. Now at higher P (new eq), unemployment is also
high, and with sticky wages theory, prices adjustslowly back to the old price. (Transitory shock only)
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Solution:
Impose expansionary policies
Shift AD to the right,
Caution: can be, in the long run, inflationary too.
Thus, anything thats expansionary is
inflationary.
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Chapter 7: anatomy of
unemployment and inflation Reasons for unemployment
New entrant
Quit
Laid- off
Shut down
Reasons for employment
Hired
re-calles
Leave labor force
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Cyclical and Frictional
Frictional
Unemployment at full employment (NRU)
Cyclical Excess of frictional unemployment (if Y < Y*)
Issues:
Unemployment benefits can also affect thebehavior of labor
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Other terms
Spell of unemployment
Continuous unemployment period
Unemployment duration Average period a person is unemployed
Frequency of unemployment
Average number of times a person is unemployed
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Unemployment: CBA
Costs of unemployment
Can hit poorer people Lower spending
Benefits of unemployment
More leisure
More business start ups
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Inflation CBA
Cost of inflation
If Perfectly anticipated, then make sure youperfectly adjust
taxes and interest rates (boost spending)
Exchange rates (trade)
If imperfectly anticipated,
Incomplete contracts are wasted (an efficientcontract should be state- contingent)
Wealth redistribution can be bad (lag effects onincome)
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QUIZ (No erasures, maximum of 3 sentences only)
Part I Discuss how the following can affect
unemployment:
1. Elimination of unions2. Increased participation of teenagers in the
market
3. Larger fluctuations in the AD
4. Increase in unemployment benefits5. Elimination of minimum wages
6. More drop-out rates
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QUIZ (No erasures, maximum of 3 sentences only)
Part II
Demonstrate in a graph the following:
1. There is a supply shock in oil. What happens to AD-
AS curves:a) During the shock
b) After the shock
2. Explain the equilibrium paths.
(Assume that it is a transitory shock)
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