Consider an economy in the medium-run equilibrium (where the wage-setting and
the price-setting curves cross). Suppose that more workers join trade unions, which increases their bargaining power against employers. Assume that the level of employment
and the labour supply remain constant in the short run.
(a) Using the labour market diagram show what happens to unemployment and real
wages in the labour market in the medium run.
(20 marks)
(b) Using the bargaining gap concept, explain what happens to wages, prices and inflation as the economy adjusts from the initial equilibrium to the new equilibrium.
Show on the Phillips curve diagram what happens to inflation.
(20 marks)