Question

1. Define the natural rate of unemployment in terms of wage-setting and price-setting relations. Write the equation that expresses the natural rate of unemployment in terms of these relations. Using an appropriate diagram, explain the effect of a decrease in unemployment benefits on the natural rate of unemployment.
     

Answer 1

Natural Rate of Unemployment

The 'natural' rate of unemployment is one of those disputable ideas that will promptly incite irate tirades from the counter entrepreneurs in any financial matters class when it gets raised. The appropriate response from the bad-to-the-bone free-marketeers would be that unemployment is a sign of market disappointment, and that in the event that you had impeccably working work advertises (no lowest pay permitted by law, no advantages, no worker's organisations and so on) at that point wages would tumble to a low enough level to take out unemployment.

We had a wage-setting relation and a price-setting relation . We can think of these in terms of real wages .

For the wage-setting relation, we will have to assume for this. This is often seen as a medium-run assumption. When you have something in economics being ‘expected’, like expected prices, expected inflation, the idea is usually that the expected and the actual values can differ in the short-run, but peoples’ expectations won’t be wrong indefinitely, eventually expectations will adjust to the point where expectations catch up with reality, this is the ‘medium run’.

So in the medium-run the wage-setting relation is , so .

And the price-setting relation is

The natural rate of unemployment is defined as the unemployment rate such that the real wage determined in wage-setting and price-setting relations is the same – this is equilibrium in the labour market. You can represent this with a diagram with (W/P) on the vertical axis and u, unemployment, on the horizontal axis.

The rate at which the two come into harmony gives the natural rate of unemployment.

The pay setting bend is descending slanting, catching the way that higher unemployment prompts lower compensation. So shouldn't something be said about different factors in this model, the 'get all' factor and the 'increase'?

On the off chance that things in the 'get all' factor change, this will move the compensation setting bend up or down. For example if there is an expansion in worker's guild power, or increment in benefits, this will expand labourers' bartering power, so it will move the WS bend up. This will lead it to cross the value setting bend at a higher 'natural' rate of unemployment. This is the issue of 'insiders v pariahs' that occasionally comes up in connection to banters about worker's guilds, frequently when associations get more power, they increment the wages of those previously working, to the detriment of making it progressively hard for untouchables to look for some kind of employment in the business.

On the off chance that things in the 'increase' change, (for example, an expansion in non-work costs for firms, or an increment in showcase control enabling them to charge costs further above costs) at that point this will move the cost setting connection, yet recollect that in light of the fact that as far as genuine wages,, , the increase is on the denominator here, so those cases referenced above which would build the increase, increment the denominator of this condition so they move the PS bend downwards. This will likewise expand the natural rate of unemployment.