JOHANNES KEPLER UNIVERSITÄT
DEPARTMENT OF ECONOMICS
IK: Einkommen Inflation and Arbeitslosigkeit WS08/09
Worksheet 9: The labour market, wage and price determination
12 January 2009
Question 1
a. Name the two main factors on which the bargaining power of employees rest.
b. In what circumstances will worker bargaining power be higher?
c. In what circumstances will employer bargaining power be higher?
d. Which of these two circumstances from (b) and (c) do you think best describes the
plight of the unemployed workers in a typical developing country? How do you
think this differs from the situation in a developed country?
e. Name another way (as opposed to increasing their skill level) in which workers
can affect their bargaining power and give an example from a developing country.
f. Explain the difference between efficiency and reservation wages.
g. Why would a company choose to pay efficiency wages?
h. Do you think that most fast food establishments pay reservation wages or
efficiency wages? Explain.
Question 2
Consider the labour market of Novindus characterised by the following:
Firms mark-up over cost = 8%
Wage setting relation: W = P(1-u)
a.
b.
c.
d.
Determine the real wage.
What is the natural rate of unemployment?
If the price level index is 110, determine the nominal wage to the nearest cent.
Explain why employers and employees are concerned with real wages rather than
nominal wages.
e. In this model we have assumed that P = Pe.
(i)
Why is the uncertainty in the future price level a concern for employees?
(ii)
In what way do people protect themselves from this risk in their
employment contracts?
f. If the mark-up over cost increases to 10% what will the new natural rate of
unemployment be?
g. From your answers to (b) and (e) explain how more competition in the goods
market can affect the natural level of unemployment.
Question 3
a. Define the wage setting relation (an equation) and explain all the variables and
whether they are directly/inversely related to the real wage rate, in this equation.
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b. Define the price setting relation (an equation) and explain all the variables and
whether they are directly/inversely related to the real wage rate, in this equation.
c. Given z held constant what is the relationship between unemployment and the real
wage?
d. Give an example of a situation that would be captured in the model through an
increase in z.
e. In (d), is the increase in z related to an increase or decrease in employee
bargaining power?
f. Given all things held equal and using this model only, will the increase in z have a
positive or negative result on worker welfare?
g. In reality we know that living standards have certainly risen over time (think
about medicine, nutrition, electricity…). Surely real wages have thus risen over
time…
(i)
Using this model, how can real wages rise in equilibrium?
(ii)
Does this account for the rise in living standards over time? What have
we excluded and how has it been removed from the model?
h. Explain the concept of the natural level of employment and the natural level of
output. Over what time period do we assume that the economy returns to the
natural level of output?
i. How can the natural level of output change?
Question 4
a. With the support of an appropriate diagram explain how the following situations
may affect real wages and the natural rate of unemployment. Make sure that you
explain the economic rationale behind the changes. If you feel that real wages
and the natural rate of unemployment will be unaffected you must justify this
view.
(i)
An increase in unemployment benefits
(ii)
An increase in the mark-up on cost
(iii) Greater legal protection of employed workers makes the process of
replacing workers more onerous
(iv)
Trade union leadership becomes so divided that it splits into two
opposing parts
(v)
The government increases the minimum wage that can legally be paid
to workers
b. What assumptions have we made in this model to get to the production function
Y = N.
c. What assumption have we made in this model regarding the returns to labour?
Hint: read the appendix of the chapter.
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