When the unemployment rate falls to levels of 4.6 to 4.7 percent we would expect there to be a lot of pressure on wages to increase. So far this year, this has not been the case; employers have been successful in holding back wage increases. As the unemployment rate falls, the labor market gets tighter; that is, it gets progressively more difficult to hold on to current workers and to recruit new ones. The last time the unemployment rate fell below 5% in the early 1970s, employers had to increase wages to attract and retain workers. This time is different.

Employers have expanded their recruitment efforts in ways and areas that were not attempted before. For example, the Walt Disney Company is recruiting in Puerto Rico where the unemployment rate is three times that of the US. Companies are looking at areas of the country and targeting demographic groups that have relatively high unemployment rates. Jobs are being listed on the Internet. Firms are offering bounties to employees that recruit individuals to the firm. Some firms are reducing their standards for jobs that are difficult to fill.

In the past, paying high wages was not as much of a problem as it is today. Firms could pass the burden of the higher wages to its customers. Competition, however, has made raising prices while maintaining profits more problematic. Although firms have to date been successful in holding down wage increases, many question whether this can continue.

1. What is the natural rate of unemployment?
2. Draw a labor demand and labor supply curve carefully noting the equilibrium wage and employment. Show on this diagram the impact of an increase in labor demand on the equilibrium wage and employment.
3. According to the article, what are some of the ways that firms have moderated the increase in wages? How would you show this on the above diagram?
4. What is the impact on the short-run aggregate supply curve of an increase in wages? On the long-run aggregate supply curve?
5. What is the relationship between the natural rate of unemployment and inflation?