Chapter 6 Part2 7(Whole) Nw

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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Chapter 6 Part2 7(Whole) Nw