okay so now in chapter seven what we have is sort of an understanding of the relationship between the unemployment rate and the wage and the wage and the overall price level and so what we want to do is put them together into a macro economic model of the unemployment rate and how that's related to the price level so in order to do that we need to make a few more steps and a few more uh assumptions so the first assumption is going to be that we get our expectations of the price level correct so that the wage depends on the actual price level and not the expected price level and that's going to be important because in our price determination equation we didn't have the expected price level we had the actual price level that's a fairly minor assumption especially these days when we don't get a lot of unexpected inflation but obviously unexpected inflation is going to affect that so this means that you know when the unemployment rate goes up we have a lower real wage and when the unemployment rate goes down we have a higher real wage and we call this the wage setting relation and we're going to graph basically the wage against the unemployment rate in order to determine the actual unemployment rate we need to go back to our price setting equation so now remember our price setting equation was that p is equal to 1 plus the markup times the wage so all we do here in equation 7.5 is divide both sides by the wage and we get price divided by wage is equal to 1 plus the markup now the problem here is that we've got the opposite of the real wage right we've got p over w instead of w over p so what we need to do is just invert both sides and then that gives us w over p that is our real wage and then we get 1 over 1 plus m so remember m is the markup m is going to be something like 10 or 20 or 30 percent it's the cost above your marginal cost that firms are able to charge now the markup's important in the economy basically it gives you sort of the level of overall competition when competition is fierce the markup is low um and so when the markup is going down right that's in the new in the denominator and so the real wage is actually going to be going up and when the markup is high when there's less competition that's going to mean that the real wage is going uh down now the interesting thing is that this is the real wage right and so what we're interested in is how much uh the wage can actually buy things um with less competition you might have a high nominal wage but the prices are going to be high right because the markup is high and so your real wage will actually be low whereas the opposite is true when there's a lot of competition the nominal wage might not seem high but the prices will be so low that if the real wage will actually be higher and so price setting decisions these are going to determine the real wage paid by firms and look there's no unemployment rate here right so this is going to be interesting this is just going to give us a horizontal line as we'll see and then where the two meet is really we just set the two equal right so we have the real wage is equal to our function of the unemployment rate in z and then we have the real wage is equal to one over one plus m we set the two equal and then the unemployment rate that meets that criterion is what we call the natural rate of unemployment and what we'll see uh in a couple chapters is that this is the unemployment rate that is consistent with uh sort of constant inflation right no change in inflation inflation isn't going up uh or down um one thing to note so this is obviously a very important unemployment rate and you can kind of think of it as like an average unemployment rate over sort of the business cycle or maybe the minimum unemployment rate depending on what's going on with uh inflation it's going to depend on the markup uh so that's important so as we'll see we can sort of see what will happen as the markup changes when we graph it and it's going to depend on z and z are all those sort of labor market institutions and rules that are going to affect the unemployment rate um so we call this natural rate of unemployment or maybe the structural rate of unemployment and there's really i mean there's some debate about whether or not this is a good concept and so we can talk about that um i think one danger is that when you know sort of you accept this argument then as the unemployment rate goes down in an expansion the central bank may feel like they have to start raising interest rates in order to check off inflation even before they see inflation and so we'll talk about that some more so here's our graph now as i said the price setting relationship is just 1 over 1 plus m there's nothing in the unemployment rate right so we have our unemployment rate here on the horizontal axis we have the real wage here on the vertical axis and our price setting relation completely determines uh the real wage our wage setting relation does depend on the unemployment rate right and so and when the unemployment rate is really low the wage setting relation is high and when the unemployment rate is really high the wage setting relationship is low now remember we're in the medium run here right so there's nothing that says we can't have a low unemployment rate and a high unemployment rate in the short run but in the medium run whatever that means we should be here at point a at the natural unemployment rate where the real wage is equal to one over one plus m now that real wage that actual number that doesn't necessarily i mean it's not something you would necessarily solve for again this is a model that's going to allow us to think about what happens when something shifts right so when either the wage setting relation shifts or the price setting relationships and the price ending relation is only going to shift um when m changes right because that's the only variable in that relationship so when m goes down the real wage is going to go up we're going to shift up and we'll have a lower natural rate of unemployment so this is interesting because this implies that more competition will actually reduce the natural rate of unemployment and then less competition when m goes up that's going to shift it down and so we'll have a higher natural rate of unemployment we can also see what's going to happen you know if we shift our ws curve and so the ws curve can shift because of z really right that's what our sort of catch-all variable is but we have to think about what's going on so this example is about unemployment benefits so the idea is all right i increase unemployment benefits that sort of increases workers bargaining power that shifts the wage setting curve to the right and actually doesn't change the wage at all because the wage is completely determined by the markup but just increases the natural rate of unemployment so there's some argument to be made for example that you know some european countries that have higher unemployment benefits end up with a higher unemployment rate um natural unemployment rate than uh countries like the united states that maybe have less generous unemployment benefits um okay maybe that you know i think you know it's not going to be this huge jump right it might be a couple percentage points but at most but we can talk about that we can look at some of the data as well and then as we said shifting the price setting curve is is going to change the real wage which will then also change the natural rate of unemployment so an increase in the markup which would be because of less competition in the economy will shift the price setting curve down increase the natural rate of unemployment and have a lower real wage and so that's something you definitely don't want to do so let's look at the data here so we've got the unemployment rate in red on the right and we've got corporate profits before tax on the left so why profits well the markup is basically a measure of profits right and so this would say that when profits are high the unemployment rate should be high and when profits are low when the markup is lower the unemployment rate should be lower um i think we see that somewhat maybe um [Music] but not necessarily clearly right these are sort of dominated by short-run fluctuations right the unemployment rate is dominated by short-run fluctuations the you know the economists do then the bls does a measure of the natural rate of unemployment but it's really just a weighted average i don't i don't really trust it i don't think it's measuring what it thinks it's measuring we can also do a scatter plot so this is a scatter plot of corporate profits in the unemployment rate um and so you can see there's not a lot of explanatory power there uh maybe a little bit that says um you know it's downward sloping so a higher unemployment rate leads to lower profits and a lower unemployment rate leads to higher profits or the other way around right these are just correlations um so not necessarily supporting uh this model completely well all right so we're almost done with chapter seven the last video in chapter seven is just looking at the appendix and sort of looking at a different way to look at the labor market so far we've assumed that the price level is equal to the expected price level and one of the things that we want to allow in the medium run is for those two not to be equal because the price level can change when there are changes to the labor market right and so if you know people are setting wages and prices based on their expectations and then either demand is higher than expected or lower than expected then the ending price level is going to be different than uh expected price um so in the medium run we would expect you know sort of firms and wages to adjust their prices um but and that's what we'll do in in chapter eight right is that we will relax that assumption and we'll start looking at you know an expected price level that can't that might not be the same as the ending price level