LABOR MARKETS AND UNEMPLOYMENT IN THE LONG-RUN

Read "Europe's scrap-heap" from the Economist, August 18, 2001
and answer the following questions.

1.  Explain what determines workers' real wages (hint: recall ch. 3 material).  Show this graphically.

2.  Rearrange the profit maximizing condition, which is derived in ch. 3, and show how the price level (of the final good or output) depends on wages and productivity. Explain the effects on the price level when (i) wages increase and (ii) productivity increases.

3.  Use the labor market graph to show how:
    (i)    higher wages affect unemployment
    (ii)   higher level of productivity affects wages, employment and unemployment.

4.  When productivity growth slows down (or productivity falls) and growth in real wages does not slow down (or real wages do not fall), what is the implication for the unemployment rate?  Show this graphically.

5. Consider this quote from the article:
"In the long run, this [higher costs] further reduces the demand for labour, because firms have less machinery and equipment to operate".
Why would demand for labour reduce when firms have less capital? Show (and explain) this mathematically and graphically.

6.  Why are unemployment rates generally higher in Europe than in the U.S.?  Is the natural rate of unemployment (the long-run equilibrium unemployment rate) higher in Europe than in the U.S.?

7.
a)  How would the natural rate of unemployment (the long run equilibrium unemployment rate) be affected if the cost of firing workers is high?  Consider the effects on the separation rate and the finding rate and carefully explain your answer.
b) If the unemployment rate increases (due to a supply shock), how would a high cost of firing workers affect the adjustment towards the natural rate?  Why?