Labour Market WS-PM model

Question 1

What is the workers side of this model

Answer 1

Wage determination

Question 2

What is collective bargaining?

Answer 2

• wage setting by bargaining between firms and unions
• In most European countries collective bargaining is the predominant mean by which wages are set

Question 3

Reservation Wage

Answer 3

The wage that would make you indifferent between working and being unemployed - typically workers are paid more than their reservation wage

Question 4

Wages also depend on labour market conditions, what are these?

Answer 4

• Lower unemployment rate
• Higher wages

Question 5

What does lower unemployment suggest?

Answer 5

Normally suggests that output is relatively high and this could be an economic boom, what we have observed in the past is that workers enjoy higher wages during these times

Question 6

In the absence of collective bargaining do workers still have bargaining power?

Answer 6

Yes they most certainly do, this depends on the nature of the job and the labour market conditions (if is unemployment low, then it is harder to find a replacement, more jobs available also leads to more bargaining power)

Regardless of a workers bargaining power, employers may want to pay more than the reservation wage, as this makes for a happier work environment and more motivated staff

Question 7

What are efficiency wage theories?

Answer 7

Theories that link productivity of workers to wages they are getting paid

1. The type of firm they work for
2. Labour market conditions

Question 8

What is the wage-setting equation

Answer 8

W = PeF(u,z)

The aggregate nominal wage depends on 3 factors: The expected price level, the actual unemployment and the catchall variable that consists of all other variables that might effect wage setting

Question 9

What is the expected price level?

Answer 9

• Both workers and firms care about real wages, not nominal wages
• Workers: care about nominal wages (W) they receive relative to the price of goods they buy (P)
• Firms: care about nominal wages (W) they pay relative to the price of goods they sell (P)
  Why expected price level and not P? - Because nominal wages are set for at least a year

Question 10

The actual unemployment rate

Answer 10

• This impacts nominal wages in a negative way, as higher unemployment lowers wages and lower unemployment raises wages

Why the negative relation?
1 - Bargaining power, During good times, lots of alternatives are available, higher bargaining power

2 - Efficiency wages, During good times, reservation wages go up, there for the overall wage level goes up, employees want to keep workers so will make wages higher

Question 11

What is the catchall variable (z)

Answer 11

All other factors given the expected price level and unemployment

Will define z so that an increase in z implies an increase in wages

Question 12

Catch all variable - Unemployment benefits

Answer 12

• Higher unemployment insurance means higher wages
• Higher unemployment insurance increases reservation wage, if you had no protection unemployment becomes scarier and your reservation wage would go down, therefore the wage that you would bargain for would also go down

Question 13

Catchall variable - Employment protection

Answer 13

• Higher protection means higher wages
• Higher protection makes it more expensive to lay off workers: so this increases employee’s bargaining power
• A positive relationship implied here

Question 14

Catchall Variable - Minimum wage

Answer 14

• Higher min wages obviously means higher wages
• Raise in min wage lowers the demand for unskilled workers
• Again positive relationship

Question 15

What is the Firms side of the model?

Answer 15

Price determination - the prices set by firms depending on the costs they face

Question 16

In our model what is our only production function?

Answer 16

Labour
Y = AN

Question 17

What is the natural rate of unemployment

Answer 17

The natural rate of unemployment is the rate of unemployment when the labour market is in equilibrium.

Question 18

What is the price-setting equation?

Answer 18

w/p = 1/(1+u)

In this equation the u is the markup on goods

Question 19

What does the natural rate of unemployment graph look like?

Answer 19

Answer on paper

Question 20

How would the equilibrium change?

Answer 20

If unemployment was lower the real wage would be higher and vice vursa

Question 21

Why is the WS curve downward sloping

Answer 21

This is because real wages have a negative relation with the rate of unemployment

Question 22

What would happen if a change was to occur in the z variable - let’s say an increase in unemployment benefits

Answer 22

• The WS curve would shift upwards to WS’
• The prospects of unemployment would be less scary
• Reservation wage would increase
• For a given P level, expect a nominal wage increase as well
• unemployment rate would also increase

SHOW ON GRAPH

Question 23

What would happen if there was a change in the PS - Let’s say an increase in mark-ups

Answer 23

• This means there is a decrease in effective real wage firms are willing to pay
• PS shifts downwards to PS’
• Equilibrium shifts from A to A’
• Unemployment increases as now firms are willing to pay lower wages, and workers will have to adjust their expectations
• Higher levels of unemployment means the economic function is not as good, fewer jobs are available and worker’s reservation wage goes down

SHOW ON GRAPH