The Supply Side of the Macroeconomy: Unemployment and Real Wages Study Notes

Overview of the Labour Market Model

• The primary objective of this unit is to construct a model of the labour market to understand the interactions between wages, prices, and unemployment.

• This model represents the supply side of the aggregate economy, focusing on the supply of inputs (specifically labour) rather than the demand for goods and services.

• The supply-side model helps explain global trends and cross-country differences—specifically why high-income countries using similar technologies and global markets exhibit varied unemployment rates and real wage growth.

• The model introduces the wage-setting (WS) and price-setting (PS) curves, which are derived from decisions made within individual firms.

Measuring the Macroeconomy and Labour Market Classifications

• Aggregation in Macroeconomics: Aggregation involves adding data together to produce one representative number for the entire economy, such as aggregate demand, aggregate wages, or aggregate prices.

• The Demographic Structure of the Labour Market:

  • Total Population: The entire group of people in a country.

  • Population of Working Age (WAP): Defined as everyone aged $15\text{--}64$ years.

  • Not in Population of Working Age: Those excluded because they are too young (under $15$) or too old (over $64$).

  • Labour Force: Comprised of both the employed and the unemployed who are willing and able to work.

  • Out of the Labour Force (Inactive): Individuals in the working-age population who are neither willing nor able to work (e.g., full-time students, retirees, or those performing unpaid household work).

South African Labour Market Definitions

• Broad vs. Narrow Definitions:

  • Narrow Labour Force: Excludes discouraged work-seekers. Individuals must be actively seeking work to be included.

  • Broad Labour Force: Includes discouraged work-seekers—those who are willing and able to work but have stopped actively looking for jobs.

• Economically Active: Those within the labour force (employed and unemployed).

• Economically Inactive: Includes discouraged work-seekers (under the narrow definition) and those who are neither willing nor able to work.

• Labour Underutilisation: Statistics SA tracks several indicators including:

  • Employed persons.

  • Unemployed persons.

  • Time-related underemployment.

  • Potential labour force (available but not seeking; or seeking but not available).

  • Discouraged job-seekers.

Key Labour Market Statistics and Formulas

• Participation Rate: The proportion of the working-age population that is in the labour force.

  • $\text{Participation Rate} = \frac{\text{Labour Force}}{\text{Population of Working Age}} \times 100$

• Unemployment Rate: The proportion of the labour force that is currently unemployed.

  • $\text{Unemployment Rate} = \frac{\text{Unemployed}}{\text{Labour Force}} \times 100$

• Employment Rate: The proportion of the working-age population that is in paid work or self-employed.

  • $\text{Employment Rate} = \frac{\text{Employed}}{\text{Population of Working Age}} \times 100$

Case Study: South African Labour Market Data (Q1 2022)

• Data Points:

  • Working-age population: $40\,033\,000$

  • Narrow labour force: $22\,776\,000$

  • Narrowly unemployed: $7\,862\,000$

  • Discouraged work-seekers: $3\,752\,000$

  • Employed people: $14\,914\,000$

• Calculated Indicators:

  • Employment Rate: $\frac{14\,914\,000}{40\,033\,000} \times 100 = 37.25\%$

  • Narrow Unemployment Rate: $\frac{7\,862\,000}{22\,776\,000} \times 100 = 34.52\%$

  • Narrow Participation Rate: $\frac{22\,776\,000}{40\,033\,000} \times 100 = 56.89\%$

Structural Challenges in the South African Economy

• The Unemployment Crisis: There are over $12$ million unemployed people in South Africa, with approximately $10$ million classified as long-term unemployed.

• Structural Nature of the Problem: Policy debates often focus on marginal job creation rather than addressing the entrenched, structural nature of unemployment and widening inequality.

• Economic Paradigm Shifts: Experts argue for a "war effort" or a "New Deal" style mobilization of resources. Current strategies focus on stabilizing network industries (electricity, rail), which creates only a small fraction of the required jobs.

• De-industrialization: The economy retains a semi-colonial, minerals-exporting character. Liberalization measures, such as removing tariffs, heavily damaged critical industries like textiles and clothing.

• State vs. Private Sector Role: While other developmental states (Asian Tigers, China) relied on leading state intervention, South Africa’s state is seen as stepping back and relying on a private sector that is currently hoarding cash rather than investing.

• Youth Unemployment: In Q1 2025, the unemployment rate for youth (15\text{--}34) reached $46.1\%$, up from $36.9\%$ in 2015.

  • The NEET (Not in Employment, Education, or Training) rate for the $15\text{--}34$ bracket is $45.1\%$.

  • Women face a higher NEET rate ($48.1\%$) compared to men ($42.2\%$).

  • $58.7\%$ of unemployed youth have no previous work experience, creating a cycle where they cannot get hired without experience but cannot gain experience without being hired.

The "Real" Wage and Consumer Price Index (CPI)

• Nominal Wage ($W$): The actual physical amount of money received in a given currency as payment for work.

• Consumer Price Index (CPI): A metric that tracks the total price of a common "shopping basket" of goods and services (food, utilities, rent, healthcare, etc.).

• Real Wage ($w = W/P$): Shows how much an individual can actually afford to buy with their salary by accounting for price changes over time.

  • Example Scenario: If a nominal wage is $R100$ and bread costs $R25$, the real wage is $4$ loaves. If the price of bread rises to $R50$ due to petrol price increases, the nominal wage remains $R100$, but the real wage drops to $2$ loaves.

The Supply Side Model: Actors and Arenas

• Key Actors:

  • Firm Owners: Employ workers and sell the output.

  • Households: Purchase goods; members are either employees or unemployed.

• Excluded Groups: The model ignores those who are self-employed or out of the labour force.

• Interacting Arenas:

  • Labour Market: Firms act as employers (demand for labour), and households act as workers (supply of labour).

  • Product Market: Firms act as sellers, and households act as customers.

• Core Assumptions:

  • Total output: $Y$

  • Price of one unit of output: $P$

  • Total employment: $N$

  • Labour Productivity ($\lambda$): Defined as output per worker, calculated as $Y/N$. This is assumed to be constant.

Decision-Making within the Firm

• Human Resources (HR) Department: Responsible for decisions in the labour market. They set wages specifically to ensure workers can be recruited and will provide effective effort.

• Marketing Department: Responsible for decisions in the product market. They set prices for the firm's products to maximize profits.

The Wage-Setting (WS) Curve

• The WS curve represents the relationship between the real wage set by HR departments and the aggregate level of employment in the economy.

• Shape: It is an upward-sloping relationship between employment ($N$) and the real wage ($w$).

• Labour Market Conditions:

  • Tight Market: High employment/low unemployment. Workers have better alternatives, so firms must pay a higher real wage to recruit and ensure effort.

  • Loose/Slack Market: High unemployment. Workers have fewer options, allowing for lower wages while still maintaining effort.

The Price-Setting (PS) Curve

• The PS curve represents the relationship between the real wage and employment based on marketing department price-setting.

• Shape: It is represented as a horizontal line in the aggregate economy.

• Function: The marketing department sets a price ($P$) proportional to the nominal wage ($W$) to maximize profit. This leads to a constant aggregate real wage ($W/P$) regardless of employment levels.

• Determinants of Price-Setting:

  • Production Costs: Depend on nominal wages ($W$) and labour productivity ($\lambda$).

  • Competition: Intense competition forces lower prices, which increases the real wage for workers.

• Real Profit per Worker: The vertical distance between output per worker (productivity) and the real wage on the PS curve.

Recruitment and the Reservation Wage

• Reservation Wage: The overall value of a worker's next-best alternative—usually remaining unemployed and seeking another job. This is the minimum wage a worker would accept to take a job.

• No-Shirking Wage (NSW): The wage HR must offer above the reservation wage to provide workers with an incentive to work hard rather than "shirk" (avoid effort).

Shifters of the Wage-Setting Curve

• Upward Shifts (Lowering the intent to work at a given wage):

  • Rise in Unemployment Benefits: Increases income while unemployed, raising the reservation wage.

  • Quality of Life Changes: If being unemployed becomes relatively more attractive (e.g., the job no longer offers remote work flexibility).

  • Increased Labour Demand elsewhere: Higher likelihood of better offers.

  • Other employers raising wages.

  • Monitoring Difficulties: If it is hard to catch shirking, wages must be higher to motivate effort.

  • High Firing Costs: If firing is difficult or costly for the firm (due to training costs or morale), workers fear job loss less and require higher pay for motivation.

  • Increased Disutility of Work: If the work standard is raised or the workplace relationship deteriorates, making work more unpleasant.

Equilibrium and Involuntary Unemployment

• Nash Equilibrium: The intersection of the WS and PS curves. At this point, neither owners nor workers have an incentive to change their behavior individually. Owners maximize profit; workers provide the required effort for the offered wage.

• The Necessity of Involuntary Unemployment:

  • If unemployment were zero, the cost of losing a job would be zero (employment rent = 0).

  • Without a cost of job loss, workers would not fear being fired for shirking.

  • If workers do not provide effort, there is no production and no profit.

  • Therefore, equilibrium must occur at a point where some unemployment exists to ensure the threat of job loss motivates effort.

• General vs. Partial Equilibrium:

  • Partial Equilibrium: Focuses on one specific market (e.g., just the labour market) while assuming everything else remains unchanged.

  • General Equilibrium: Studies how actors across different markets (labour and product) interact and how effects carry over (e.g., how labour market wages affect firm costs, which affect product market prices, which then affect worker living standards).