Suppose labor productivity improves. How would that affect the real wage and the natural rate of unemployment?
The correct answer and explanation is:
When labor productivity improves, it typically leads to higher output per worker. This shift can impact both real wages and the natural rate of unemployment, although the effects depend on several factors.
Effect on Real Wages:
Labor productivity and real wages are often positively correlated. If workers are able to produce more output per hour worked, employers may be willing to pay higher wages for this increased productivity. Higher productivity means that workers can contribute more to a company’s overall output, which makes them more valuable to employers. As a result, businesses may increase wages to retain or attract skilled workers. This generally leads to an increase in real wages because productivity gains allow for greater earnings without causing inflationary pressure, especially in a competitive market.
Effect on the Natural Rate of Unemployment:
The natural rate of unemployment refers to the rate of unemployment that is expected to prevail in an economy over the long term, even when it is operating at full potential. It includes frictional and structural unemployment but does not reflect cyclical unemployment caused by economic downturns.
When labor productivity improves, the natural rate of unemployment may decrease in the short run. This happens because productivity increases typically stimulate economic growth, leading to greater demand for goods and services. As businesses expand, they hire more workers, which can reduce the unemployment rate. However, if the productivity gains are concentrated in certain industries or sectors, there could be structural unemployment as workers in less productive sectors struggle to find new opportunities.
Overall, labor productivity improvements can lead to higher real wages and potentially lower the natural rate of unemployment, depending on how effectively the economy adapts to the changes in productivity. However, long-term changes depend on the broader economic context, such as technological advancements, shifts in industry demands, and government policies.