A Graphical Analysis of the Wage Curve and the Price Curve. Wage Curve: ω󰇛󰇜 Add inflation to both sides of the wage curve. Real Wage Curve ω󰇛󰇜󰇛󰇜 Then we can draw this. We find the intercept by setting 0; the slope is – (the effect of a little more unemployment on requests for real wage raises). Change the price curve ω so that it has real wage growth on the left hand side. First, subtract  from both sides; then subtract 󰇛󰇜 from both sides. 󰇛󰇜󰇛󰇜󰇛󰇜ω Simplify by canceling 󰇛󰇜ω Rearrange so it looks pretty, and then put real wage growth 󰇛ω󰇜 on the left hand side. ω Price Curve, expressed in terms of the real wage ω Then we can draw this. Since unemployment doesn’t show up in the equation, we draw it as a horizontal line at . ω uWage Curve −α 󰇟󰇠 Equilibrium is determined by the point where the two curves intersect, or by the solution to the system of equations formed by the Wage Curve and the Price Curve. To find equilibrium unemployment (in both the short‐run and the medium‐run; that is,  may or may not equal ), we need to combine the Wage Curve with the Price Curve, and solve. 󰇛ω󰇜W C󰇛ω󰇜P C 󰇛󰇜󰇛󰇜󰇛󰇜 󰇛󰇜󰇛󰇜󰇛󰇜  󰇛󰇜󰇛󰇜 1󰇟󰇛󰇜󰇛󰇜󰇠 Short‐run Unemployment 1󰇟󰇛󰇜󰇛󰇜󰇠 ω uPrice Curve Wage Curve −α 󰇟󰇠  ω uPrice Curve  Also, remember that we can calculate the natural rate of unemployment by setting  1󰇟󰇛󰇜󰇛󰇜󰇠 1󰇟󰇛0󰇜󰇛󰇜󰇠 Natural Rate of Unemployment 1󰇟󰇠 Changes in unemployment benefits, worker sensitivity to unemployment, non‐labor costs, or productivity growth change unemployment in both the short‐run and in the medium‐run. un rises if Z or  rise. un falls if  or α rise. • If unemployment benefits, Z, rise, workers will be less scared of unemployment: unemployment rises. It takes a higher rate of unemployment to force workers to bring their wage‐raise requests down. o Alternatively, consider that a union neg otiates both the wage for its members and the amount of workers that are hired. (It knows that by asking for high wages for members, it will lead to more unemployment among non‐members). If labor unions are more powerful, and the union will be emboldened to ask for more. Again, it takes more unemployment‐pain to bri ng wage demands down. o If workers become more sensitive to unemployment (higher α), the Wage Curve will become steeper. It now takes a smaller increase in the unemployment rate to bring workers’ wage requests down. Because they are more sensitive, it now takes lower unemployment to get workers to be willing to take the same real wage raises 󰇛ω󰇜, so equilibrium u falls. ωuWage Curve Price Curve  󰇟󰇠 󰇟󰇠 • If markups increase or if Non‐Labor Cost inflation speeds up, unemployment rises o Higher costs or monopoly power leads to higher Prices. If 󰇛󰇜 doesn’t change (that is, if workers change their expectations to match the change in P), then the real expected wage 󰇛ω󰇜 has to fall. To get workers to accept a real wage cut, unemployment must rise. o If productivity growth falls, unit labor costs will be higher, leading to higher inflation and higher unemployment. This is a shift down (as shown above) of the Price Curve and leads to a decrease in equilibrium unemploymen t. In the short‐run, unemployment may also change (and may deviate from the natural rate of unemployment) if . Notice, from the formulas for equilibrium unemployment and for the natural rate of unemployment, that If , then  If , then  ωuWage Curve Price Curve  󰇟󰇠  ω uPrice Curve Wage Curve −α 󰇟󰇠  • If actual inflation exceeds expected inflation 󰇛󰇜, that is, if workers expect inflation to be lower than it actually is, workers’ requests for raises will be relatively moderate compared to increases in prices. Firms will be able to afford the raises and even to expand payroll. So if actual inflation exceeds expected inflation, unemployment is below the natural rate of unemployment, . • If expected inflation exceeds actual inflation 󰇛󰇜, workers will demand faster raises. But since firms’ costs () and worker productivity () haven’t changed, firms won’t be able to afford the raises. They will encourage workers to accept the smaller raises by laying off workers: if actual inflation falls below expected inflation, unemployment is above the natural rate of unemployment, . Notice that this situation cannot be a medium‐term equilibrium. Eventually, workers will realize that their expectations of inflation are wrong. They will revise  so that it matches the actual . In this example, where we had , expected inflation will fall, shifting the Wage Curve down, back to the original level. In the medium run, . ωuWage Curve Price Curve  󰇟󰇠 󰇟󰇠unu> unShow the effect of a decrease in unemployment benefits or labor‐union militancy. Does this affect the natural rate of unemployment or just short‐run unemployment? Show the effect of a decrease in workers’ sensitivity to unemployment. Does this affect the natural