Question

Suppose that the wage-setting equation, evaluated at medium run equilibrium, is ?/? = A(z – u), where z denotes workers' reservation wage.

(i) Calculate the natural rate of unemployment as a function of z, the markup m, and the stock of technology A.

(ii) Show the effect of an increase in A on the natural rate of unemployment and the real wage.

Answer 1

A) At natural rate of unemployment P= P^e, where P^e is the expected price.

We also have , where m is the markup price.

From above two equations we will get natural unemployment rate,

B) We can show that increase in A on   as

This shows that natural unemployment rate will increase as A goes up.

From equation 1 we get that

Which says, if

and