L9 - Determination of Wage,Price and Supply

Question 1

What is determined to be the only variable input in the production process in the SR?

Answer 1

Labour

Question 2

What are the factors affecting money wages (W)

Answer 2

 The level of employment (N): when employment levels are high, the demand for labour is high and so wages are bid up as firms try to recruit more staff and retain existing staff

 The price level (P) is also likely to influence wage bargaining as workers attempt to maintain the purchasing power of their real wage rate

Question 3

Why are wage bargains struck?

Answer 3

Since actual future level of P not known, wage bargains struck on basis of expected future price level (Pe)

As Pe rises money wage expected to rise.

Institutional factors (trade unions, unemployment benefit (z) may also positive influence wage independent

Question 4

What is the equation for the Expected Real Wage?

Answer 4

W/Pe = f(N,z)

Where,
F is a function of/Depends on

Question 5

How do you convert expected real wage to actual real wage?

Answer 5

-Both sides need to be multiplied by Pe/P thus:
(W/Pe)(Pe/P)=(Pe/P)f(N,z)

-Pe’s cancel on the LHS and so we have:

w = W/P= (Pe/P)f(N,z)

Question 6

How do you calculate actual real wage?

Answer 6

w = W/P= (Pe/P)f(N,z)

DIAGRAMMATICALLY SHOWN ON NOTES

Unexpected rises in price level reduce real wage rate

Question 7

What is the Price Setting Equation?

Answer 7

P=(1+μ)W

Where:
μ is constant mark up
W is money wage costs

DIAGRAMMATICALLY ON NOTES

Since u> 0 then prices exceed unit costs by extent of mark up
Says Firms prices set independent of demand

Question 8

Why is there a mark up in the price setting equation?

Answer 8

Firms assumed to operate in imperfectly competitive markets and set prices as mark up on average prime costs

Question 9

What is the Price Setting Equation in terms of real wage rate?

Answer 9

W/P= 1/ (1+μ)

μ is a mark up

Question 10

What is the interpretation of the complete labour market diagram?

Answer 10

level of employment, N0, is that level of employment that is consistent with firms’ price-setting behaviour and worker wage bargaining (Natural Level of Employment)

Price-setting decisions determine the real wage paid by firms. An increase in the mark-up leads firms to increase their prices given the wage they have to pay; equivalently it leads to a decrease in the real wage

Question 11

What is the Natural Level of Employment?

Answer 11

The level of employment that is consistent with firms’ price-setting behaviour and worker wage bargaining

Question 12

How do we translate the Labour Market into AS?

Answer 12

To translate the level of employment into output we need a production function

Y =ΦN
With Φ being marginal product of labour
N being the level of labour
Normally a production function has K but this is fixed in the Short term

 wage-setting relation is simply:
W/P = (Pe/P)f(Y/Φ, z)
And the real wage rate is directly related to the level of output produced

Substituting for W/P, using the price-setting relation and re-arranging gives the relation for AS
1/(1+μ)= Pe/P.f(Y/Φ, z) or P = Pe (1+μ)f(Y/Φ, z)

Question 13

What is the AS relation equation?

Answer 13

P = Pe (1+μ)f(Y/Φ, z)

Where,
Φ being marginal product of labour
μ is a mark up
z is unemployment benefit

Question 14

What does the AS relation equation say?

Answer 14

• The price level and output are positively related for given levels of Pe, μ, Φ and z
• An increase in μ or z (or a fall in Φ) will lead to the AS-curve shifting up, as P rises at each level of output
• If P=Pe then the level of output is at the natural or potential level and independent of the price level. This will be the LRAS curve

Question 15

How do you derive the SRAS Curve?

Answer 15

Aggregate of points along the W/P line.

SEE DIAGRAM ON NOTES

Question 16

What causes shifts in the SRAS Curve?

Answer 16

 A rise in the mark-up, indicating greater monopoly power of firms in the goods market, leads to an upward shift the SRAS curve

 A rise in productivity – Φ – will lead to a fall in P and a downward shift of the SRAS curve
 A rise in z – perhaps due to an increase in unemployment benefits, also leads to an upward shift in the SRAS curve – DIAGRAM ON NOTES

Question 17

What does the Short Run AD/AS Model look like?

Answer 17

 If PP0 then desired (and actual) spending is consistent with a level of GDP that is less than the desired output of firms

SEE DIAGRAM ON NOTES