RDP 9509: Australian Wage and Price Inflation: 1971–1994 Appendix A: Imperfect Competition Model of Inflation

This appendix solves a simple imperfect competition model of inflation of the Layard/Nickell tradition.

Price Equation

Wage Equation

Where p, w, U, p^e and ϕ are the price level, average wage, unemployment rate, expected price level and productivity with lower case variables in logs. The shift variables for the wage and price equations are z_p and z_w respectively.

Eliminate the real wage from (A1) and (A2):

Long-run unemployment rate or NAIRU when ΔU = 0 and p − p^e = 0:

Deviations from NAIRU:

Eliminate unemployment from (A1) and (A2):

Long-run real wage when ΔU = 0 and p − p^e = 0:

Deviation from long-run real wage:

The Impact Of Shocks On Unemployment and Real Wage

Effect of wage shock on NAIRU and long-run real wage:

   which is zero if firms price independently of demand and, therefore, β₁ = 0.

Effect of price shock on NAIRU and long-run real wage:

Effect of productivity shock on the NAIRU and long-run real wage: