The WS-PS model of the labour market The Macro approach to the Labour market

The WS-PS model of the Labour market IS-LM model examines 2 markets : the goods market and the money market This allows us to determine 2 variables: The equilibrium Output The equilibrium rate of interest But we’ve assumed that prices stay fixed!! This might be OK in the short run But is otherwise unrealistic

The WS-PS model of the Labour market Problem: We want to determine prices (inflation) as well as output and interest rates How do we do that? We have to add another market (i.e. Another equilibrium equation) It turns out that the required market is the labour market This is because it is the market for the main factor of production

The WS-PS model of the Labour market Definitions The Wage-Setting equation The Price-Setting equation The structural rate of unemployment

Definitions Employed population (ILO definition) People that are at least 15 years of age; People that have worked (even for a single hour) during the reference period even if self employed, or employed in a family business; People that are employed but on temporary leave of absence (illness, maternity leave, training, etc.); Members of the armed forces, apprentices, paid interns, are part of the active population.

Definitions Economically Active population in France (ILO definition, 2004)

Definitions Unemployed (ILO definition) According to the 1982 definition, a person is unemployed if he/she is a member of the working age population (15 years or more) and fulfils the following conditions: Is not employed : has not worked a single hour during the reference period; Is available for work within 15 days ; Is actively searching for employment.

Definitions Total French Population (60 Million) Working Age Population (39) Economically Inactive Population (21) Labour force (Economically active population) (27) (12) Employed population (25) Unemployed (2)

Definitions Total French Population (60 Million) Working Age Population (39) Economically Inactive Population (21) Labour force (Economically active population) (27) (12) Employed population (25) Unemployed (2)

Definitions Total French Population (60 Million) Working Age Population (39) Economically Inactive Population (21) Labour force (Economically active population) (27) (12) Employed population (25) Unemployed (2)

Definitions Average monthly flows (France, 2005) Employed 24,6 221 138 98 418 216 527 82 398 Unemployed 3,2 Inactive 12,0 19 140 44 070 Average monthly flows (France, 2005)

Definitions The unemployment rate in France First Oil Shock Second Oil Shock Recession Economic recovery The unemployment rate in France

The WS-PS model of the Labour market Definitions The Wage-Setting equation The Price-Setting equation The structural rate of unemployment

The WS Equation Wages can be determined in several ways Individual negotiations Branch agreements (Trade union negotiations) National legislations Two main factors play a role: The reservation wage The wage at which one is indifferent between working or remaining unemployed Market conditions These determine the bargaining power of the employee.

The WS Equation The bargaining power (BP) of a worker is a function of two factors: The ease with which the firm can replace him Higher likelyhood of replacement ⇒ ↓ BP This is linked to the skills of the worker and/or the job characteristics The ease with which he can find another job Higher likelyhood of finding job ⇒ ↑ BP This is linked to the level of unemployment

The WS Equation The nominal wage W is a function : Of the expected level of prices Pe Negotiations occur at discrete intervals (every X years) They are based on the expected purchasing power for the duration of the interval Of the rate of unemployment u High unemployment reduces the BP of workers Market factors z Institutional factors (unemployment benefits) Structural changes in the economy (skill biased TC)

Real wages are a negative function of the rate of unemployment The WS Equation Real wages are a negative function of the rate of unemployment Real Wage WS Unemployment rate u

Real wages are a positive function of market conditions The WS Equation Real wages are a positive function of market conditions Real Wage WS’(z’>z) WS(z) Unemployment rate u

The WS-PS model of the Labour market Definitions The Wage-Setting equation The Price-Setting equation The structural rate of unemployment

The PS Equation The actual level of prices is determined by the wage rate W represents the marginal cost of production In the SR, output is a function of labour: Y=N Assumption : constant returns to scale (1 + μ) : markup on the goods markets μ=0 : perfectly competitive market μ>0 : Imperfectly competitive market In choosing μ, the firms influence the level of the real wage

The PS Equation Rearranging the PS equation allows us to express the real wage as a function of the markup rate... This way we can draw the PS equation in the same space as the WS equation

The PS Equation Real Wage PS Unemployment rate u The real wage induced by the PS equation is independent of the rate of unemployment PS Unemployment rate u

The WS-PS model of the Labour market Definitions The Wage-Setting equation The Price-Setting equation The structural rate of unemployment

The structural rate of unemployment The structural rate of unemployment un equalises WS and PS The structural rate of unemployment: Is independent of short-term fluctuations As a result it is often called “natural” but this is incorrect un is a function of the structural parameters on the labour market z Unemployment benefits, production technology, etc. un is a function of the structural parameters on the goods market μ Barriers to entry, level of competition, etc.

The structural rate of unemployment The labour market equilibrium implies that the wages determined through the bargaining process are consistent with the price setting behaviour of firms Real Wage A un WS PS Unemployment rate u

The structural rate of unemployment WS’ 1. An increase in unemployment benefits shifts WS to the right (better labour market conditions)... Real Wage A’ u’n 2. ...Which increases the structural rate of unemployment A un PS WS Unemployment rate u

The structural rate of unemployment PS’ 1. An increase in the level of competition reduces the markup... Real Wage u’n A’ 2. ... Which reduces the structural level of unemployment A un PS WS Unemployment rate u