ABSTRACT
Modern macroeconomic theorists have come around to a belief that labor markets, like the product markets, are best represented by the assumption of imperfect competition. There are two kinds of imperfectly competitive models of the labor market. One model, based on the dynamics of wage setting under trade unions, emphasizes collective bargaining power. Another model, based on efficiency wage models of the firm, emphasizes that individual workers have bargaining power. In either case, the wage bargain depends on the unemployment rate. For low levels of Gross Domestic Product (GDP), workers will receive a real wage that exceeds the bargained real wage. In this case, employers will press for money wage reductions and a downward spiral of wages and prices will ensue. A low level of output gives rise to a deflationary gap that leads to falling wages and prices. Collectively firms generate an upward-sloping Aggregate Supply (AS) curve through the wage-setting behavior in the labor market.
