Question

Using queue theory, explain why trying to use fiscal or monetary policies to reduce structural unemployment can lead to wage inflation.

Answer 1

The equilibrium of a labor market with friction is derived using Queue Theory. The queue theory provides the expressions for number of vacancies, queueing workers and job searching workers. When the number of workers in a firm increases, the unemployed workers who searching for vacancies were change to waiting in queues. To calculate the equilibrium of a labor market with friction, queue theory give labour economy by an analytic tool

By increasing the rate of economic growth and by supporting to increase aggregate demand, the Fiscal Policy can decrease the unemployment. The government will persue the fiscal policy, this will cuts the taxes and increase the givegovern spending. The disposable income will increase by lowering taxes and it helps to increase in consumption leads to higher aggregate demand. The real GDP increase as the result of increase in AD . If a firm produce more, demand of workers increase and it lowers the rate of unemployment.

The central bank will increases the money supply when the rate of unemployment increases and the economy want to grow. The increasing money supply is the result of the Monetary Policy. Monetary policy continuosly try to keep short-term real rates less will cause eventually to increase in Inflation and high nominal interest rates.