Derivation of the Inflation Rate from Expected Inflation and the Bargaining Gap
The inflation rate can be derived from the process of wage and price setting, under the key assumption that wages are the sole cost of production. The derivation follows a logical sequence:
- Inflation is defined as the percentage increase in prices.
- This price increase is equivalent to the percentage increase in costs per unit of output.
- If wages are the only cost, this is equal to the percentage increase in wages.
- The wage increase is determined by the sum of expected inflation and the bargaining gap.
This chain of reasoning can be expressed formally: \begin{align*} \text{inflation (%)} &\equiv \text{increase in prices (%)} \ &= \text{increase in costs per unit of output (%)} \ &= \text{increase in wages (%)} \ &= \text{expected inflation (%) + bargaining gap (%)} \end{align*}
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