2 - Fluctuations in Employment, Wages and Inflation

Question 1

What is the equation for inflation?

Answer 1

π_t=100(P_t-P_t-1)/P_t-1

Question 2

What is inflation?

Answer 2

The percentage change in the price index.

Question 3

What is the equation for the output gap?

Answer 3

y_t-y^e

Question 4

What is the output gap?

Answer 4

The difference of output from its equilibrium level.

Question 5

What is the equation for equilibrium output?

Answer 5

y^e=f(E^*)

Question 6

What is equilibrium output?

Answer 6

Level of output consistent with the labour market equilibrium.

Question 7

Why do workers make nominal wage demands?

Answer 7

• Workers demand compensation for expected inflation
• If they have sufficient bargaining power, they demand higher wages

As unemployment falls, wage demands increase as demand for workers exceeds supply.

Question 8

Why do firms accept nominal wage increases?

Answer 8

• Firms will meet expected inflation as they will increase prices to maintain profit at the pre-inflation levels.
• By offering higher wages due to worker bargaining power, they increase economic rent of working therefore reducing worker turnover and increase effort.

Question 9

What is the wage equation?

Answer 9

ΔW_t/W_t-1 = ΔP_t-1/P_t-2 + α(y_t-y^e)

W = nominal wages, P = price level, y = output

Question 10

What does ΔP_t-1/P_t-2 mean in the wage equation?

Answer 10

The expected inflation.

i.e. last period’s inflation.

Question 11

What is α in the wage equation?

Answer 11

Sensitivity of wage demands to excess output.

Question 12

What is α relative to the PS and WS curve?

Answer 12

The gradient.

Question 13

What is the price equation?

Answer 13

P = (1 + μ)W/λ

W = nominal wages, λ = labour productivity, μ = monopoly markup

Question 14

What do price changes depend on?

Answer 14

• positively on wage changes
• negatively on productivity changes

(assuming a fixed markup)

Question 15

How large is μ in the price equation if the firm is a monopoly?

Answer 15

Very large.

Question 16

What is W/λ?

Answer 16

The marginal cost.

Question 17

How does the price equation link to the PS curve?

Answer 17

Rearranged.

W/p = λ/(1+μ) = PS curve.

Question 18

What is the only way to get real wage increases without inflation?

Answer 18

Increasing productivity.

Government can’t really intervene on a major scale to reduce monopoly markup across all markets.

Question 19

What is the equation of the Phillips Curve (PC)?

Answer 19

π_t = π_t-1 + α(y_t-y^e)

Question 20

Why is the change in productivity held at 0 when considering the PC?

Answer 20

Inflation changes are looked at over years or months, not decades where productivity changes are seen.

Question 21

Draw the PC with unemployment on y-axis.

Answer 21

Question 22

How should you lay out the wage-setting process on a table?

Answer 22

Question 23

Sketch this table on a graph.

Answer 23

Question 24

What is the GDP deflator?

Answer 24

C + I + G + X

Ratio of nominal GDP to real GDP

Question 25

Why does the labour market not clear?

Answer 25

The wages at which you recruit a worker and motivate them to work hard are different.

Question 26

Why are there rigidities in wage setting?

Answer 26

They are set periodically, rather than constantly adjusted.

Question 27

What sets the reservation wage?

Answer 27

Unemployment benefit plus the utility of unemployment

Question 28

Why may employment not rise when output rises?

Answer 28

Okun's Law Those who have been kept on payroll but working shorter than normal hours will be asked to increase their working hours.

Question 29

Following a positive price shock, what happens to the PC?

Answer 29

Shifts up.

Question 30

Following a positive price shock, what happens to the PS curve?

Answer 30

Shifts down. W/P, as P increases, W/P (i.e. PS curve) shifts down.