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The economic puzzle of stable or falling US unemployment despite declining competition can be explained by the concurrent weakening of labor unions. In the WS-PS model, while reduced competition shifts the price-setting (PS) curve down (increasing unemployment), weaker union power shifts the wage-setting (WS) curve down (decreasing unemployment). As illustrated in the analysis of Figure 2.24, the combined effect can lead to an outcome where inequality increases, but the downward pressure on unemployment from the WS shift offsets or even surpasses the upward pressure from the PS shift. This can result in stable or even lower unemployment, aligning the model with empirical observations.

Reconciling the US Unemployment Puzzle: Combined Effects of Weaker Unions and Declining Competition

Figure 2.24 depicts the initial state of the labor market, with employment on the horizontal axis (ranging 0-90) and the real wage on the vertical axis (ranging 0-λ). The labor force is represented by a vertical line at an employment level of 90. The model includes a horizontal line for the average product of labor (λ) and a lower horizontal price-setting (PS) curve corresponding to a wage share of 79% (at 0.79λ). The initial equilibrium is at point A, with coordinates (83, 0.79λ), where the upward-sloping, convex wage-setting (WS) curve intersects the PS curve. At this point, unemployment is represented by the 7 individuals between the employment level of 83 and the total labor force of 90.

Figure 2.24: Initial Equilibrium Setup

The WS-PS model can be extended to illustrate the implications for inequality that arise from the combined effects of rising market power, the weakening of trade unions, and the emergence of the gig economy. This comprehensive analysis is depicted in Figure 2.25.

Application of the WS-PS Model to the Gig Economy and Inequality

An economist is studying a country's labor market over the past two decades and observes four key trends: (1) The national unemployment rate has remained relatively stable. (2) Major industries have become more concentrated, with fewer large firms dominating their markets. (3) The percentage of the workforce belonging to labor unions has significantly declined. (4) The share of national income paid to workers as wages has decreased, while the share going to firm owners as profits has increased. Using a framework where firms set prices as a markup over costs and workers' wages depend on their bargaining power, explain how these four trends can be mutually consistent. Specifically, identify the two opposing pressures on the unemployment rate and the combined outcome for the real wage.

Analyzing Labor Market Trends

Within the wage-setting and price-setting framework, a widespread decrease in market competition among firms occurs. In isolation, this change would lead to a higher equilibrium rate of unemployment. However, observed data shows the unemployment rate remained stable. Explain what simultaneous change in the labor market could account for this stability and describe the resulting net effect on the equilibrium real wage.

Reconciling Labor Market Shifts

An economic model suggests that the puzzle of stable US unemployment, despite firms gaining more pricing power, can be explained by a simultaneous decline in workers' collective bargaining strength. Critically evaluate this explanation. In your answer, discuss the opposing effects these two forces have on the equilibrium unemployment rate and the real wage, and assess the overall plausibility of this combined explanation for observed economic trends.

Evaluating Competing Forces in the Labor Market

The analysis presented in Figure 2.24 shows that a simultaneous increase in firms' market power and a decrease in workers' bargaining power can result in higher inequality without a corresponding rise in unemployment. In the example depicted, the new equilibrium at point C actually has a lower unemployment rate than the initial situation at point A.

Analysis of Combined Labor Market Shifts in Figure 2.24

Consider an economy where two changes occur simultaneously over several years: 1) a general decrease in market competition allows firms to set prices further above their production costs, and 2) a widespread decline in the negotiating strength of workers reduces their ability to secure higher pay. What is the most likely combined outcome for the economy's equilibrium real wage and unemployment rate?

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