Analyzing an Economic Shock with the Wage-Price Setting Model

An economy is initially in a medium-run equilibrium where the real wage workers require is equal to the real wage firms offer. The government then enacts a new policy that permanently increases the level of unemployment benefits. Assuming firms' markup over costs remains unchanged, arrange the following events to describe the logical sequence of the economy's adjustment to a new equilibrium.

Labor Market Adjustment to a Policy Change

Consider an economy initially in a medium-run equilibrium. A new government policy strengthens workers' bargaining position, causing an upward shift in the wage-setting curve. At the original level of employment, what is the immediate consequence that initiates the adjustment process toward a new equilibrium?

Product Market Competition and Labor Market Outcomes

Consider an economy in a stable, medium-run equilibrium. The government then introduces a policy that strengthens the power of labor unions, causing the wage-setting relationship to shift upwards. A union leader subsequently claims, 'This policy will lead to a permanent increase in the real wage for our members at the current level of employment.' According to the logic of the wage-setting and price-setting framework, this claim is correct.

An economy is initially in a medium-run equilibrium. A policy change then causes a permanent downward shift in the price-setting (PS) curve. Match each phase of the subsequent adjustment process with the correct description of the economic actors' behavior or the state of the labor market.

An economy is in a medium-run equilibrium. A new government policy provides a permanent subsidy to firms, reducing their non-labor costs. This causes an upward shift in the price-setting (PS) curve. At the original equilibrium level of employment, what is the fundamental inconsistency that initiates the adjustment to a new equilibrium?

Evaluating a Policy Response to a Labor Market Shock

The Wage-Price Adjustment Mechanism