Chapter 7: Unemployment Rate and Price Level

Jun 26, 2024

Chapter 7: Unemployment Rate and Price Level in Macro Economics

Key Concepts

  • Relationship between Unemployment Rate, Wage, and Price Level
  • Macro-economic model to link unemployment rate and price level

Assumptions

  1. Accurate Expectations of Price Level
    • Wage depends on actual price level, not expected price level
    • Important because of minor unexpected inflation

Wage Setting Relation

  • Unemployment Rate Effects: Low Unemployment = Higher Real Wage, High Unemployment = Lower Real Wage
  • Graph: Wage vs. Unemployment Rate

Price Setting Equation

  • Equation: P = (1 + Markup) × Wage
  • Rearrange: P/W = 1 + Markup ⟹ W/P = 1 / (1 + Markup)
  • Markup:
    • Cost above marginal cost
    • Lower competition = Higher markup = Lower real wage
    • Higher competition = Lower markup = Higher real wage

Natural Rate of Unemployment

  • Determined by:
    • Wage = function of Unemployment Rate and Z
    • Wage = 1 / (1 + Markup)
    • Unemployment rate where both equations meet is the natural/structural rate
  • Characteristics:
    • Consistent with constant inflation
    • Average or minimum unemployment rate over business cycle
    • Depends on Markup and Z (labor market institutions and rules)

Implications and Graphical Representation

  • Price Setting Relationship:
    • Horizontal line at 1 / (1 + Markup)
  • Wage Setting Relationship: Depends on unemployment rate
  • Natural Rate: Occurs where both relationships intersect
  • Changes in Markup (M):
    • Higher M = Lower Real Wage = Higher Natural Unemployment Rate
    • Lower M = Higher Real Wage = Lower Natural Unemployment Rate
  • Effects of Z (example: unemployment benefits):
    • Increase in Z (better benefits) increases natural unemployment rate

Critique and Debate

  • Impact of central bank raising interest rates when unemployment drops, even without inflation
  • Debate on effectiveness and measurement of the natural rate by organizations like BLS

Data Analysis

  • Scatter Plot: Relationship between corporate profits and unemployment rate
  • Findings: Weak evidence supporting the direct relationship model

Appendix Preview (Chapter 8)

  • Medium Run Adjustments: Allowing difference between expected and actual price levels
  • Impacts of Labor Market Changes: Higher/lower demand affecting ending price level