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

2. 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

3. 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

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

5. 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.

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

7. 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.

8. 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)

9. 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)

10. 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)

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

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

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

14. 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.

15. 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

16. 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)

17. 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

18. 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

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

20. 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

21. 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

22. 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

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

24. 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.

25. 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

26. 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

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