W4P5 - Labour Market Stocks

Question 1

What happens to employment and wages if inflation is HIGHER than expected?

Answer 1

When inflation is higher than expected π > π^e. Real wages (w) are now lower than anticipated and hence firms are demanding more
labour. In a labour market diagram with collective bargaining, this
would imply that the collective labour supply schedule is shifting down
and the real wage decreases from w1 to w¯. Involuntary
unemployment decreases from U0 to U1.

Question 2

What are real wages (w) defined as?

Answer 2

w = W/P

Question 3

Typically, what happens in a wage negotiation?

Answer 3

nominal wages are agreed and the union has certain expectations about the inflation in the future.

Question 4

What happens to employment and wages if inflation is LOWER than expected?

Answer 4

When inflation is lower than expected π < π^e.

Then real wages are higher than anticipated and hence firms are demanding less labour. The collective labour supply schedule would
shift up and unemployment increases.