In the WS-PS Framework, what would be the impact of i) a positive productivity

shock and ii) a decline in worker bargaining power? Comment on voluntary and
involuntary unemployment in each case. More generally, in what circumstances will a
shift in either line not lead to a change in involuntary unemployment?

• Under Imperfect Competition, the equilibrium W/P

is where WS = PS.

• The equilibrium level of employment is E.

• The equilibrium wage is We

We
• Note, here PS is horizontal as in the Carlin &
Soskin book. We are assuming the special case
where the profit-share of firms is counter-
cyclical to a degree that fully offsets MPL.

• Usually, PS is downward sloping.

E
 impact of i) a positive productivity shock

• Productivity parameter part of Price-Setting

Curve. W/P

• Increase in productivity will increase the wage

under the price setting curve.

• PS curve shifts up.

W’
• Equilibrium employment increases and the We
equilibrium real wage increase.

• This is a positive supply shock.

• However, the effect of a rise in productivity is

limited if the firm uses it as an opportunity to
increase profit share. E
impact of ii) a decline in worker bargaining power

Zw are any wage-push factors. A decline in

W/P
•

worker bargaining power comes under wage-

push factors.

• A fall in worker bargaining power will cause

the wage under the Wage-Setting curve to fall.

• WS shifts down.
W’
We
• The equilibrium level of employment has
increased further (unemployment has
decreased), but there is no additional change to
the real wage.

E
impact on PC.

W/ W
P S
WS
’

• Output level also increases to Ye’.

W PS
’ ’
W P
• At the original output level, there is now a e
S
negative gap between PS’ and WS’. W
L

• Wage setters respond to this gap by reducing

their real wage claim to WL. This is because of E
π E E’ L
their decline in bargaining power.

• Wages therefore rise by 0% and, in order to

P
keep their profit margins constant, firms do not C
change prices. P
C’

• Inflation falls from 2% to 0%. 2

%
0
%
Y
Y Y
e e
’
 voluntary and involuntary unemployment.

• Voluntary unemployment - when the

unemployed choose not to accept a job at the
prevailing wage.
W/P
• Involuntary unemployment - when an
unemployed person is willing and able to work
at the prevailing wage.

• Voluntary unemployment = the distance

between total labour force, L, and Labour
Supply, Ls at the prevailing wage. W’
We
involu

• Involuntary unemployment = the distance

between the equilibrium level of employment,
E’, and labour supply Ls at the prevailing
wage.

• Both voluntary and involuntary unemployment E

decrease as a result of the shifts of WS and PS
 in what circumstances will a shift in either line not lead to a change in involuntary
unemployment?

• Under perfect competition, the equilibrium is

where labour supply is equal to labour
demand: Ls = LD.
W/P
• Therefore, there is no rationalisation for
involuntary unemployment under perfect
competition. So there would be no change in
involuntary unemployment in a competitive
labour market.

W’
We