Question

The rising international integration of economies has led to increasing competitive pressure. Suppose that, as a result, firms can more easily move some of their operations abroad, making them stronger when bargaining with their workers. As we saw in Chapter 7, weaker bargaining power on the part of workers is likely to have implications for the natural rate of unemploy- ment.

Explain and illustrate the short-run and medium-run impacts of this development using the IS-LM-PC model. In so doing, ex- plain globalisation’s impact on the Phillips Curve by tracing its effect back to the associated changes in Blanchard’s model of the labour market. (40 Marks)

Answer 1

Globalization impacts the bargaining power of workers and shifts the short-run Keynesian aggregate supply curve, influencing the Phillips Curve tradeoff between inflation and unemployment. Over time, with wages and prices adjusting, the economy tends to move back to its potential GDP. The speed of these macroeconomic adjustments remains a contentious issue among economists.

Step-by-step explanation:

The question concerns how globalization and increased ability of firms to move operations abroad can affect the bargaining power of workers and implications for the natural rate of unemployment. In the context of the IS-LM-PC model, movements of operations abroad could lead to a weaker bargaining position for domestic workers. This can result in a lower natural rate of unemployment in the short run, as firms are less inclined to offer high wages domestically. The Phillips Curve illustrates a short-run tradeoff between inflation and unemployment, which would now be influenced by these global movements.

In the short run, if unemployment is high, the bargaining power of workers declines, leading employers to offer lower wages. This can shift the short-run Keynesian aggregate supply curve to the right, reducing the price level and potentially affecting inflation rates. In the medium run, with wages and prices becoming more flexible, the impact on unemployment might be neutralized as the economy adjusts to the potential GDP, affecting both inflation and unemployment rates. Thus globalization, by influencing the labor market, can affect the short-run inflation-unemployment tradeoff represented by the Phillips Curve, and potentially shift the long-run Phillips Curve if the changes are permanent.

The neoclassical view suggests that in the long run, potential GDP and aggregate supply determine the size of real GDP, and that adjustments in wages and price levels rectify situations of unemployment. A key question is the speed at which macroeconomic adjustments occur, indicating the practical relevancy of different economic theories.

Answer 2

Globalization affects the Phillips Curve by increasing firms' bargaining power, which can raise unemployment and lower inflation in the short term. Over time, the economy adjusts back towards potential GDP as wages and prices become flexible, aligning with neoclassical theory.

Step-by-step explanation:

The concept of globalization impacts the Phillips Curve, showing an inverse relationship between inflation and unemployment. In the short run, increased competitive pressure from globalization might increase unemployment due to firms moving operations abroad and weaker worker bargaining power. This change leads to a rightward shift in the short-run aggregate supply curve (SRAS) due to reduced wage demands, influencing the IS-LM-PC model by potentially lowering inflation but increasing unemployment. In the medium run, according to neoclassical theory, the economy adjusts as wages and prices become more flexible, moving towards potential GDP and reducing the pressure on the price level, although real GDP's size remains determined by aggregate supply.

Expansionary and contractionary monetary policy play roles in adjusting inflation and unemployment levels. Expansionary policy can decrease unemployment but might lead to higher inflation, whereas contractionary policy might reduce inflation but increase unemployment. Over time, if wages and prices adjust slowly, the short-term effects of increased unemployment and decreased inflation may persist longer than in the traditional Keynesian perspective.