Part II The model of wage-price determination and the Philips curve debates Hick's ISLM model shows the relationship between the rate of interest ( i ) and the aggregate output ( Y ). This model, however, does not explain how the overall price level (P) in the economy is determined and changed as the aggregate output (Y) changes over time along the business cycle. From now on, we are going to analyze this missing price variable (P) and consider how the aggregate output and the overall price level interact with one another along each phase of the business cycle. One conventional starting point is to consider the real wage variable (W/P) determined in the labor market. Relying on both Ch. 6 \& 8 and Prof.'s lecture notes, respond to the following analytical questions. 9. Using your own intuition, think about various economic variables that affect the price level in the economy. What kinds of variables can we think of, and in what way would they affect the overall price level in the economy? Is your thought similar to or different from Keynes's cost of production approach to inflation? 10. One important variable that affects the price level is the nominal wage, because the labor cost is one important factor that affects the cost of production. From the perspective of the representative employee or worker, the nominal wage is his or her labor income, whereas the same variable is a cost to the business operation from the employer or firm's point of view. Suppose that this worker's labor income or nominal wage is a certain function of unemployment rate on the one hand and federal minimum wage and/or unemployment insurance on the other. Suppose also that the worker tries to form a certain expectation about the future price level when she negotiates with her employer over the appropriate nominal wage. How would you set up a general equation that describes this behavioral pattern, using a general notation? Part II The model of wage-price determination and the Philips curve debates Hick's ISLM model shows the relationship between the rate of interest ( i ) and the aggregate output ( Y ). This model, however, does not explain how the overall price level (P) in the economy is determined and changed as the aggregate output (Y) changes over time along the business cycle. From now on, we are going to analyze this missing price variable (P) and consider how the aggregate output and the overall price level interact with one another along each phase of the business cycle. One conventional starting point is to consider the real wage variable (W/P) determined in the labor market. Relying on both Ch. 6 \& 8 and Prof.'s lecture notes, respond to the following analytical questions. 9. Using your own intuition, think about various economic variables that affect the price level in the economy. What kinds of variables can we think of, and in what way would they affect the overall price level in the economy? Is your thought similar to or different from Keynes's cost of production approach to inflation? 10. One important variable that affects the price level is the nominal wage, because the labor cost is one important factor that affects the cost of production. From the perspective of the representative employee or worker, the nominal wage is his or her labor income, whereas the same variable is a cost to the business operation from the employer or firm's point of view. Suppose that this worker's labor income or nominal wage is a certain function of unemployment rate on the one hand and federal minimum wage and/or unemployment insurance on the other. Suppose also that the worker tries to form a certain expectation about the future price level when she negotiates with her employer over the appropriate nominal wage. How would you set up a general equation that describes this behavioral pattern, using a general notation
