Unit 2 slides

ECO1019 Principles of Macroeconomics

Week 3: Unemployment, Wages, and Inequality

Supply Side Policies and Institutions

A. Introduction

This unit provides a comprehensive examination of disparities in unemployment rates observed between seemingly similar nations, such as Spain and Germany. The varying economic contexts, historical policies, and institutional frameworks play critical roles in influencing these disparities.

B. Inequality

Measuring Inequality

• Lorenz Curve: A graphical representation of income distribution that plots the cumulative income earned by the bottom x% of the population against the total income. The further the curve is from the diagonal line of equality, the greater the level of inequality.

• Gini Coefficient: A numerical measure of inequality derived from the Lorenz curve; it ranges from 0 (indicating perfect equality where everyone earns the same income) to 1 (indicating perfect inequality where one individual has all the income).

  • Example: The Gini coefficient for land ownership can be calculated as A/(A+B), where A represents the area between the Lorenz curve and the line of equality, and B is the area beneath the Lorenz curve.

C. Labour Market Policies and Labour Unions

Market vs Disposable Income

• Market Income: Income generated from wages, salaries, self-employment, business profits, and investments before any taxes are deducted. It reflects the true earning capacity of the population in the labor market.

• Disposable Income: Market income after the deduction of direct taxes and inclusion of cash transfers. This income is crucial for consumption and reflects the actual purchasing power of individuals.

  • Market Gini Coefficient: 0.40, indicating a moderate level of income inequality.

  • Disposable Gini Coefficient: 0.31, showing a reduction in inequality when considering disposable income after taxes and transfers.

WS-PS Model and Lorenz Curve

• WS-PS Model: The Wage-setting and Price-setting model illustrates the interaction between wage determination (WS) and overall price levels (PS) within an economy. This model helps explain how employment levels and income distribution can be significantly impacted by shifts in market conditions.

• Gini Coefficient: The model also demonstrates changes in income distribution and how inequality can fluctuate based on shifts in labor market policies and external economic conditions.

Policies Impact on Employment and Wages

• Wage Subsidy Example: Implementing a wage subsidy reduces the firm's hiring costs, thereby leading to an increase in real wages and a decrease in structural unemployment. This situation illustrates how subsidies can lead to shifts in the price-setting curve upwards as production costs lower, stimulating economic activity and employment.

• Introducing Unemployment Benefits: Adjustments in unemployment benefits can lead to increased inequality if poorly calibrated; the initial Gini coefficient impact is analyzed before and after such adjustments to depict potential outcomes. These changes can alter employment rates and subsequently impact income shares.

Labour Unions

• Labour Union Role: A labour union is an organized group that represents workers' interests in negotiations concerning pay, working conditions, and working hours. Through collective bargaining, unions can enhance their members' bargaining power, positively influencing the WS curve to achieve better wages and improved labor conditions.

D. Applications and Cross-Country Comparisons

Overview of Comparative Data

This section examines differences in unemployment rates and economic policies among countries, focusing on the role of unemployment benefits, collective bargaining processes, and market flexibility. Analysis of data spanning from 2001-2020 shows varying effectiveness of different labor market policies across nations.

Real Wage Growth Analysis

• Spain vs Germany: A detailed analysis examining average real wage growth rates against unemployment rates between Spain and Germany during the period from 2010-2019 reveals contrasting policy impacts. In Germany, robust labor market reforms and collective bargaining contributed to more significant wage stability, while Spain faced higher volatility due to less effective labor policies.

Summary

• Inequality Representation: Inequality is visually represented through Lorenz curves and quantitatively measured by the Gini coefficient, illustrating the extent of wealth distribution within societies.

• WS-PS Model: The WS-PS model is pivotal in understanding income distribution dynamics; shifts in either curve directly affect macroeconomic outcomes, highlighting the interconnectedness of wage setting and pricing.

• Market Competition: Effective competition policies aim to minimize markups in pricing, thus fostering both wage growth and higher employment levels, enhancing overall economic performance.

• Cross-Country Policy Impact: Significant disparities in institutional effectiveness and policy implementations underscore the varied economic outcomes achieved among nations, emphasizing the importance of tailored economic strategies in addressing unemployment and inequality.