The labour market

at work in the determination of wages include:
Workers are typically paid a wage that exceeds their reservation wage, the wage that would make them indifferent between working or being unemployed.
Wages typically depend on labour market conditions. The lower the unemployment rate, the higher the wages.

costly it would be for the firm to replace him—the nature of the job.
How hard it would be for him to find another job—labour market conditions.

Bargaining

8.2 Wage Determination (Continued)

of workers to the wage they are paid efficiency wage theories.

Efficiency wages

These theories also suggest that wages depend on both the nature of the job and on labour-market conditions:
Firms that see employee morale and commitment as essential to the quality of their work will pay more than firms in sectors where workers’ activities are more routine.
Labour market conditions will affect the wage.

8.2 Wage Determination (Continued)

would pay every qualified employee a minimum of $5 per day for an eight-hour day. While the effects support efficiency wage theories, Ford probably had other objectives as well for raising his wages.

expected price level, Pe
The unemployment rate, u
A catchall variable, z, that stands for all other variables that may affect the outcome of wage setting.

8.2 Wage Determination (Continued)

wages (W).
Workers do not care about how many dollars they receive but about how many goods they can buy with those dollars. They care about W/P.
Firms do not care about the nominal wages they pay but about the nominal wages, W, they pay relative to the price of the goods they sell, P. They also care about W/P.

The expected price level

Wages, prices and unemployment

8.2 Wage Determination (Continued)

think of wages as being determined by bargaining, then higher unemployment weakens workers’ bargaining power, forcing them to accept lower wages. Higher unemployment allows firms to pay lower wages and still keep workers willing to work.

The unemployment rate

Wages, prices and unemployment

8.2 Wage Determination (Continued)

all the factors that affect wages, given the expected price level and the unemployment rate.

Unemployment insurance is the payment of unemployment benefits to workers who lose their jobs.

The other factors

Wages, prices and unemployment

8.2 Wage Determination (Continued)

output per worker

Further, assuming that one worker produces one unit of output—so that A = 1, then, the production function becomes:

The production function is the relation between the inputs used in production and the quantity of output produced.
Assuming that firms produce goods using only labour, the production function can be written as:

is the markup of the price over the cost of production. If all markets were perfectly competitive,  = 0, and P = W.
We can think of the mark-up as depending on the degree of competition in the product market.

at the implications of wage and price determination for unemployment.

Let’s assume that nominal wages depend on the actual price level, P, rather than on the expected price level, .

Wage setting and price setting determine the equilibrium rate of unemployment.

price level:

This relation between the real wage and the rate of unemployment—wage-setting relation.

The wage-setting relation

8.4 The Natural Rate of Unemployment (Continued)

the real wage chosen in wage setting is equal to the real wage implied by price setting.

The wage-setting relation

Figure 8.10 Wages, prices and the natural rate of unemployment

8.4 The Natural Rate of Unemployment (Continued)

get:

To state this equation in terms of the wage rate, we invert both sides:

The price-setting relation

The price-setting relation

8.4 The Natural Rate of Unemployment (Continued)

line PS (for price setting) in Figure 8.10.
The real wage implied by price setting is 1/(1 = µ); it does not depend on the unemployment rate.

The price-setting relation

8.4 The Natural Rate of Unemployment (Continued)

obtain the equilibrium unemployment rate, or natural rate of unemployment, un:

The equilibrium unemployment rate (un) is called the natural rate of unemployment.

Equilibrium real wages and unemployment

8.4 The Natural Rate of Unemployment (Continued)

equilibrium unemployment rate, depend on both z and μ.
At a given unemployment rate, higher unemployment benefits lead to a higher real wage. A higher unemployment rate is needed to bring the real wage back to what firms are willing to pay.
By letting firms increase their prices given the wage, less stringent enforcement of antitrust legislation leads to a decrease in the real wage.

Equilibrium real wages and unemployment

8.4 The Natural Rate of Unemployment (Continued)

rate of unemployment An increase in unemployment benefits leads to an increase in the natural rate
of unemployment.

8.4 The Natural Rate of Unemployment (Continued)

of unemployment
An increase in mark-ups decreases the real wage and leads to an increase in
the natural rate of unemployment.

8.4 The Natural Rate of Unemployment (Continued)

economy, a better name for the natural rate of unemployment is the structural rate of unemployment.

Equilibrium real wages and unemployment

8.4 The Natural Rate of Unemployment (Continued)

of employment.

Employment in terms of the labour force and the unemployment rate equals:

The natural level of employment, Nn, is given by:

From unemployment to employment

8.4 The Natural Rate of Unemployment (Continued)