The WS-PS model of the labour market

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 structural rate of unemployment

The Price-Setting equation

Definitions

Employed population (ILO definition)

1. People that are at least 15 years of age;

2. People that have worked (even for a single hour) during the reference period even if self employed, or employed in a family business;

3. People that are employed but on temporary leave of absence (illness, maternity leave, training, etc.);

4. Members of the armed forces, apprentices, paid interns, are part of the active population.

Definitions

Not

Economically

active

population

33 799,2

55%

Unemployed

2 854,0

4%

Employed

population

25 146.5; 41%

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:

1. Is not employed : has not worked a single hour during the reference period;

2. Is available for work within 15 days ;

3. 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)

Economically Inactive Population(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)

Economically Inactive Population(12)

Employed population(25)

Unemployed (2)

Population Age Working

ForceLabour rateion Participat

Definitions

Total French Population(60 Million)

Working Age Population (39) Economically Inactive Population(21)

Labour force (Economically active population) (27)

Economically Inactive Population(12)

Employed population(25)

Unemployed (2)

ForceLabour

Population Employed-ForceLabour ratent Unemployme

Definitions

Employed

24,6

Unemployed

3,2

Inactive

12,0

221

138

216

527

19 140

44 070

82 398

98 418

Average monthly flows (France, 2005)

Definitions

0

2

4

6

8

10

12

14

1970 1975 1980 1985 1990 1995 2000 2005

Firs

t Oil

Sho

ck

Sec

ond

Oil

Sho

ck

Rec

essi

on

Eco

nom

ic r

ecov

ery

The unemployment rate in France

The WS-PS model of the Labour market

Definitions

The Wage-Setting equation

The structural rate of unemployment

The Price-Setting equation

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 characteristicsThe 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)

,eW P F u z

The WS Equation

Unemployment rate u

Real Wage

Real wages are a negative function of the rate of unemployment

WS

P

W

zuFP

We

,

The WS Equation

Unemployment rate u

Real Wage

Real wages are a positive function of market conditions

WS(z)

zuFP

We

,P

W

WS’(z’>z)

The WS-PS model of the Labour market

Definitions

The Wage-Setting equation

The structural rate of unemployment

The Price-Setting equation

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

1P W

The PS Equation

o Rearranging the PS equation allows us to express the real wage as a function of the markup rate...

o This way we can draw the PS equation in the same space as the WS equation

1

1

1

1

P

WW

P

WP

The PS Equation

Real Wage

The real wage induced by the PS equation is independent of the rate of

unemployment

PS

P

W

Unemployment rate u

1

1

The WS-PS model of the Labour market

Definitions

The Wage-Setting equation

The structural rate of unemployment

The Price-Setting equation

The structural rate of unemployment

The structural rate of unemployment un equalises WS and PS

o The structural rate of unemployment: Is independent of short-term fluctuations As a result it is often called “natural” but this is

incorrect

o un is a function of the structural parameters on the labour

market z Unemployment benefits, production technology, etc.

o un is a function of the structural parameters on the goods

market μ Barriers to entry, level of competition, etc.

1

1, zuF n

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

A

un

WS

PS

Real Wage P

W

Unemployment rate u

1

1

The structural rate of unemployment

A

un

WS

PS

WS’

1. An increase in unemployment benefits shifts WS to the right

(better labour market conditions)...

A’

u’n2. ...Which increases the structural rate of unemployment

Real Wage P

W

Unemployment rate u

1

1

The structural rate of unemployment

A

un

WS

PS

PS’

1. An increase in the level of competition reduces the markup...

u’n

A’

2. ... Which reduces the structural level of unemployment

Real Wage P

W

Unemployment rate u

1

1'1

1