Awareness of General Equilibrium Effects and Unemployment

Abstract

We examine wage bargaining in a two-sector economy when the employers and labor unions in each sector are not always aware of all the general equilibrium feedback effects. We show analytically that if agents only consider labor demand effects, low real wages and low unemployment are the result. With an intermediate view, i.e., when partial equilibrium effects within a sector are taken into account, high real wages and unemployment result. If all general equilibrium effects are simultaneously considered, we once again obtain a situation of low wages and unemployment. The assumption that unions and employers' federations are unable to incorporate all feedback effects from other sectors may explain why unemployment in Europe is high.

Keywords: Sectoral wage bargaining, awareness of general equilibirum effects, unemployment

JEL Classification: D58, E24, J60, L13