DP5012 Awareness of General Equilibrium Effects and Unemployment

Author(s): Hans Gersbach, Achim Schniewind
Publication Date: April 2005
Keyword(s): awareness of general equilibirum effects, sectoral wage bargaining, unemployment
JEL(s): D58, E24, J60, L13
Programme Areas: Labour Economics, Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5012

We examine wage bargaining in a two-sector economy when the employers and labour unions in each sector are not always aware of all the general equilibrium feedback effects. We show analytically that if agents only consider labour 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.