Question

On 22 February 2019 Philip Lowe, the Governor of the Reserve Bank of Australia, told the house economics committee:

"I think this country can have an unemployment rate close to 4.5 per cent [as opposed to the commonly assumed 5, or 5.5 per cent] without wage growth causing problems for inflation."

Shortly after, journalist A suggested this is good news for the government. In contrast, two days later, another journalist, journalist B, argued the opposite, that this is bad news for the government, citing the high rate of underemployment in Australia.

a) Which well-known macroeconomic concept is Governor Lowe referring to and what is it called?

b) What arguments would support the two journalists' assessments, respectively? Briefly explain.

c) Briefly explain some of the key characteristics that make the labour market different from, say, the market for chocolate bars?

Answer 1

(a) The governer philip Lowe is talking about a well known and established relationship between unemployment and inflation, surprisingly which is knows as "phillips curve"

The phillips curve states that the there is an inverse relationship between unemployment and inflation. That is to say, when unemployment decreases inflation goes up.

The argument goes like this, when unemployment decreases which is to say employment rises. The higher employment is associated with higher wage rate w, since to attract more labor firms must increase the wage rate they are offering to labors.

And as wage rate W increases, the firm's cost of production also increases which they pass on to consumers in terms of higher prices.

This is exactly what governer phillip Lowe is saying that unemployment will be lower but without wage growth. Which in turn means that inflation will not grow.

(b) The argument that would support both journalist's assessment is that labor supply is directly related to wage rate.

While the journalist A is suggesting that governer's statement is good for economy. Since low inflation rate is good for any economy.

While journalist B is suggesting that low wage rate growth could mean high rate of underemployment in Australia. Let's first understand what underemployment refers to. Underemployment is a situation when workers doesn't work to their potential for some reason, one reason might be that prevailing wage rate is simply not high enough at which workers will be willing to supply their potential labor.

The argument behind this assessment is that labor supply is directly related to wage rate W. So when wage rate W doesn't grow over time, then it creates disincentive for workers to work less. Which mean that there could be high rate of underemployment.

Mathematically the labor supply equation is given as,

W = P (L^s)

Here W = nominal wage rate

P = price level

L^s = labor supply.

(c) The key characteristic that differentiates labor market from say chocolate maket is that in labor market the demand for labor comes from firms and supply of labors comes from households. While chocolate market tha supply of chocolates comes from firms where production happens. And demand comes from households.

Another characteristic that differentiates labor market from the market of chocolate bars is, chocolate bars are final products while in labor market labor is just a factor of production which is used to produce final goods like chocolate bars.