The Phillips curve, supply shocks, and wage flexibility Supposethat the Phillips curve is given by ?? = ?? ? − ?(?? − ?? ) (1)
where the natural rate of unemployment, ?? = ?+? ? .
[Recall that this Phillips curve was derived under price-settingand wage-setting:
?? = (1 + ?) ?? (2)
?? = ?? ? (1 − ??? + ?) (3)
where m is the mark up over marginal cost, which is just thewage rate Wt when output is assumed to simply equal employment: ??= ?? We can think of ? as a measure of wage flexibility---thehigher is ?, the greater is the response of the wage to a change inthe unemployment rate, ?? . z represents other factors affectingwage bargains.]
a. Explain how you obtain (1) from (2) and (3).
