Use the WS and PS relations to show the effects of the following events on the...

Use the WS and PS relations to show the effects of the following events on the natural rate of unemployment and on the real wage. Be sure to explain the effects of the event and to illustrate your answer graphically.

a. increased anti-trust legislation leads to increased competition.

b. a reduction in unemployment insurance.

Expert Solution

* Natural Rate of unemployment is determined by Wage setting relation and price setting relation. Assuming that actual price level is equal to expected price level i.e. Pe = P. We can write both equation as -:

* WS relation shows inverse relation between unemployment rate and real wage. On the other hand PS relation is independent of unemployment rate. Equilibrium in labor market requires that real wage according to WS and real wage according to PS must be same. Therefore, unemployment rate at labor market Equilibrium is known as natural rate of unemployment. At natural rate of unemployment following equation must be satisfied -:

* The natural rate of unemployment is not constant. Infact it will change if there is a shift of PS or WS relation.

a) If there in increased anti trust legislation then there is increased competition among firms and keeps price lower. It means value of mark up decreases with competition. As a result PS relation shifts upwards and natural rate of unemployment decreases. (as shown in dig. below)

b) If there is a reduction in unemployment insurance then catchall variable decreases and WS relation shift downwards. As a result natural rate of unemployment decreases. (as shown in dig. below)

Rahul Sunny answered 7 months ago

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