Question

Why is the battly of mark-ups important for understanding the origins of inflation? Discuss the significance of each of these assumptions: (a) imperfect or monopolistic competition among firms. (b) labour unions or collective bargaining. (c) constant labour productivity.

Answer 1

The concept of mark up inflation is based on the assumption that both wages and prices are settled by labor and business firms. Firms set market prices accumulating costs associated withthe product and their fixed markup over the cost so as to incur profits. This notion is followed by workers as well to bargain wages which mark up over the costs associated with providing labour. If either or both firms and workers use percentage markup over fixed markup then inflation would shoot up more than usual.

The significance of assumptions such as:

a) imperfect or monopolistic market competition exists when firms sell similar but differentiated goods among large number of buyers and sellers and their are advertising and selling costs associated with product differentiation which lets to higher markup over costs. Barrier to entry and exit are low and firms do not make decisions based on other firms.

b) labour unions or collective bargaining implies a process of negotiation between the employer and the worker's union in order to determine the terms of employment, charge fair wage and formulate efficient working conditions.

c) constant labour productivity means the amount of goods and services produced by one hour of labour.

growth in labour productivity depends on three factors; investment and saving in physical capital, new technology and human capital.