Question

a) There are two economies, Flexiland and Fixland. These economies are identical in
every way except that in Flexiland, real wages are flexible and maintain equality between
the quantities of labor demanded and supplied. In Fixland money wages are sticky but
wages are set so that, on the average, the quantity of labor demanded equals the quantity
supplied. (4)
i) Explain which economy has the higher average unemployment rate.
ii) Explain which economy has the largest fluctuations in unemployment.

Answer 1

i)

Unemployment occurs when there is an excess in labor supply than the labor demanded. In Flexiland, Higher unemployment rate occurs due to flexible wages, as there is no equilibrium between the supply and demand of labor. Due to this disparity, people might not be interested to work for lower wages and the unemployment rate increases in this case. But on the other hand, in fixland, the money wages are fixed but the real wages (which accounts for inflation) is set at equilibrium levels. and in the long run when the market is at equilibrium, the employment will be optimal. Therefore, unemployment rate in fixland is less when compared to flexiland. Or in short flexiland has highest average unemployment rate.

ii)

Unemployment fluctuations are caused when there is a stark difference between the money wages and the real wages at equilibrium levels. In Fixland, the fluctuations in unemployment rate is more although the average unemployment rate is low. Due to the shift of real wages to accommodate for the equilibrium in labor market, this happens. Hence, the fluctuations of unemployment rate is more in Fixland.

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