The basic estimating equation employed in chapter 3 is derived from the following labor-market-oriented model. Consider an economy in which the demand for labor (DL) is determined according to the familiar marginal productivity conditions:where wr denotes the real-wage rate.
Let the supply of labor (SL) be a fixed proportion of the population, i. e., perfectly inelastic:
This assumption is reasonably consistent with the facts of American society. For purposes of simplifying the analysis,we will assume an invariant population over time.
Accompanying this real-wage version of the labor market is a money-wage version in which the demand schedule for labor is multiplied by the price level (P), so that at any point on the money-wage demand schedulewhere wm is the money-wage rate.
Assume an initial equilibrium at which wr = wr★. Now, introduce an exogenous change in the price level, induced by a change in money aggregate demand, which shifts the money-wage demand schedule for labor either to the left or to the right. In the absence of any adjustment in money-wage rates, the real-wage rate will deviate