Non accelerating inflation rate of unemployment

Milton Friedman, the economist criticised the basis for the Phillips Curve and,
introduced the concept of the NAIRU.

NAIRU is defined as the rate of unemployment when the rate of wage
inflation is stable.

NAIRU assumes that there is imperfect competition in the labour market where
some workers have collective bargaining power through membership of trade
unions with employers. And, some employers have a degree of monopsony
power when they purchase labour inputs.

Therefore with NAIRU, the equilibrium level of unemployment is the result of a

bargaining process
between firms and workers. The bargaining process:-

Workers have in their minds a
target real wage. This target real wage is
affected by:-

- what is happening to unemployment (the lower the rate of unemployment, the
higher workers’ wage demands will be).

- Workers wishing to have a bigger share of a rising level of profits when the
economy is enjoying a cyclical upturn.

Whether a business can meet the workers target real wage depends partly on:-

- labour productivity and

- the ability of the business to apply a mark-up on cost in product markets in
which they operate.

If actual unemployment falls below the NAIRU, theory suggests that the
balance of power in the labour market tends to switch to employees rather
than employers.

The consequence can be that the economy experiences
acceleration in pay
s and the growth of average earnings.

Ceteris paribus, an increase in wage inflation will cause a rise in
inflationary pressure