Economics

In simple terms, wage is inversely related to quantity of labor demanded. As wage increases, the quantity of labor demanded decreases (measured in hours). Marginal product of labor increases, ceteris paribus (MPL is the change in output resulting from hiring one additional unit of labor). In the real world however, the market model of labor is rather sophisticated. Two considerations are taken into account in the prescribed model inflexibility of wages in the short-run and bargaining power of labor unions. The prescribed model is Ld  Ln (1-(wi-)), where Ld is the overall demand for labor, n is total number of firms, L is the available labor in the economy, (wi-) is the profit-wage differential.

An increase of wage in the short run will significantly decrease the quantity of labor demanded decreases. Suppose the economy overheats, overall output decreases. Because wages tend to be inflexible in the short-run, firms are forced to reduce the quantity of labor demanded (to maintain the wage level). Now, suppose the economy operates in the long-run. If the economy overheats, a decrease in wage levels leads to an increase in quantity of labor demanded. Note that it if often wage levels which determine Ld (the rate of unemployment is expressed as ui  wi - ). Other factors are partially insignificant.

Suppose there is a change in the bargaining power of unions. Suppose a labor union demands that prevailing wages increase by 40. If the bargaining power of the union is strong, then it can pressure the management to affect the wage increase. But this does not mean that the firm will exclusively handle the additional cost of maintaining extra laborers. The firm may opt to lay-off some workers to compensate for the increase in wage. The effect of this policy can only be observed in the long-run.

The intersection of the aggregate demand-aggregate supply curves represents the real domestic output of an economy. A rightward shift of the AD curve increases real domestic output. A leftward shift of the AS curve decreases overall output. Now, suppose that the government wants to increase government spending. In the short-run, an increase in G results to an increase in AD. A decrease in G results to a decrease in AD. Price levels increase in the medium run. Suppose that the government wants to implement a monetary policy (policies formulated to change the overall supply of money in an economy). An increase in money supply results to lower interest rates, higher investments (here investors are more willing to borrow from financial institutions), and to higher AD. A decrease in money supply increases interest rates, lowers investment schedules, and ultimately AD. Price levels fall.

The Phillips Curve. This defines the historical inverse relationship between the rate of unemployment and the rate of inflation in an economy. In short, the lower the unemployment in an economy, the higher the rate of increase in nominal wages. If inflation is high, then unemployment is low. From this relationship, one can argue that inflation is the independent variable (which depends on another dependent variable). A gradual increase in Y results to a gradual increase in P. It means that the economy is self-maintaining and therefore is capable of sustaining its labor force. As such economies with high inflation often have low unemployment rates. In the long-run, however, this is not observed.

The expectations-augmented Phillips curve is a modified version of the Phillipx