Unit 1 The supply side of the macroeconomy: Unemployment and real wages

1.8 Equilibrium and disequilibrium in the WS–PS model

involuntary unemployment

A person is involuntarily unemployed if they are seeking work, and willing to accept a job at the going wage for people of their level of skill and experience, but unable to secure employment.

Unemployed people would like to change the outcome given by the intersection of the WS and PS curves, but they are powerless to do so. These people are involuntarily unemployed in equilibrium. Unlike unemployed people, the firms’ owners (and their HR and marketing departments), the customers, and the employed workers could make choices that would change the outcome, but they have no incentive to do so. This follows from the fact that the intersection of the two curves is a Nash equilibrium. To understand why this is the case, step through the thought experiment that follows.

Unemployment in the Nash equilibrium

Why will there always be some involuntary unemployment in equilibrium?

• If there was no unemployment, the cost of job loss would be zero (no employment rent) because a worker who loses their job can immediately get another one at the same pay.
• If there is no cost of job loss, the employed worker would not fear being fired if caught shirking and would be indifferent between working hard or not on the job.
• If the worker is not motivated to work hard, then there will be no output and nothing for the employer to sell, and hence, no profits.
• Therefore, some unemployment is necessary: it means the employer can motivate workers to provide effort on the job, which is essential to production.
• Therefore, the wage is always set above the reservation wage.
• It follows that in any equilibrium, where the wage and price-setting curves intersect, there must be unemployed people.

structural unemployment

The level of unemployment where the supply side of the economy is in equilibrium. In the WS–PS model, it is the unemployment level at which the price-setting real wage equals the wage-setting real wage. See also: WS–PS model, Nash equilibrium, supply side.

The unemployment observed at the Nash equilibrium of the WS–PS model is called structural unemployment because it is an outcome of the supply-side structure of the economy as represented by the two curves.

Next, we show involuntary unemployment in the WS–PS diagram. Figure 1.23 shows that there are unemployed workers at the Nash equilibrium at point A, where employment is N_A. But is this involuntary unemployment? When studying the wage-setting decision of a single firm, in Figure 1.19, we identified a group of jobseekers who would accept a job at the prevailing wage but would not be offered one.

At the aggregate level, there are jobseekers—just like those in the single firm case—who would be willing to accept a job at the wage at point A in Figure 1.23 but they will not receive an offer. To locate these jobseekers in the model, we ask, at the real wage, w_A, who is willing to accept a job. By following the arrow to the right from the vertical intercept at w_A, we go beyond point A to point V, which shows the reservation wage. The difference between employment at points A and V shows the extent of involuntary unemployment in the economy.

An outcome is termed a Nash equilibrium if none of those involved, by individually choosing a different action, could bring about an outcome that they would prefer.

Fullscreen

https://www.core-econ.org/macroeconomics/01-supply-side-macroeconomy-08-ws-ps-equilibrium.html#figure-1-23

Figure 1.23 Equilibrium (structural), and involuntary and voluntary unemployment.

voluntary unemployment

A person may be said to be voluntarily unemployed if they are seeking work, but not willing to accept a job at the going wage for people of their level of skill and experience. See also: involuntary unemployment.

The difference between point V and the labour force is a measure of voluntary unemployment in the economy: those people are seeking work but would not accept a job at the wage, w_A. They prefer free time at that wage, and are therefore described in the model as voluntarily unemployed.

Structural unemployment is the sum of involuntary and voluntary unemployment.

Banning non-compete clauses (increasing labour market competition) is predicted to raise wages

A reduction in labour market power (also called monopsony power) shifts both the PS and the WS curves upward. The key result is that because the markdown falls, the PS curve shifts up, which implies a rise in the real wage and a shift in the distribution of income from owners to workers. In the US, a key tool for exercising labour market power is the non-compete clause in employment contracts. In April 2024, the US regulator, the FTC (Federal Trade Commission), decided to ban such clauses. Our WS–PS model predicts that this will increase real wages in the US.

Employers frequently seek to increase their monopsony power in the labour market by adopting strategies that limit a worker’s ability to find alternative employment. Chief among these strategies are non-compete clauses that prevent a worker going to work for an employer competing with their current employer, after they have resigned or been fired from their job. Non-compete clauses were initially written into the contracts of a few scientists, top management, and other high-level employees who might leave the firm, bringing trade secrets to competitors.

But in the US today roughly one in five workers has agreed to such a restriction. A non-compete clause in the contract of a $13 per hour packer at Amazon in 2015 read: ‘During employment and for 18 months after the Separation Date, Employee will not, directly or indirectly, … engage in … manufacture, marketing, or sale of any product or service that competes or is intended to compete with any product or service sold, offered, or otherwise provided by Amazon …’. It’s difficult to see how an employee fired by Amazon could get any kind of job at all without violating this contract, which may be the point.

While non-competes are more common among well-paid, highly skilled workers, they are common also among workers like in Amazon’s warehouses, who are unlikely to have valuable trade secrets to pass on to a future employer seeking to compete with the marketing giant. About a fifth of personal care and services workers, for example, are subject to such contractual provisions as are one in ten food preparation and serving workers. These clauses prohibit, for example, a worker who was fired from or quit a job with McDonald’s from taking any job in the fast-food business, substantially limiting their chances of finding work. Prohibiting non-compete clauses in contracts would make labour markets more competitive and, by improving workers’ reservation fallback options, put upward pressure on wages.

Lina Khan, Chair of the Federal Trade Commission

In April 2024 the Federal Trade Commission of the US Government did just that: it declared illegal the non-compete clauses in the contracts of 30 million American workers. The FTC’s chair, Lina Khan said: the ‘rule to ban non-competes will ensure Americans have the freedom to pursue a new job, start a new business or bring a new idea to the market.’ The FTC report on their decision found that non-competes tend to negatively affect competitive conditions in labour markets by inhibiting efficient matching between workers and employers.¹

In the WS–PS model, Khan’s argument is represented by the upward shift of the WS curve when non-compete clauses are banned. HR departments will have to offer higher wages to recruit and motivate workers, who will no longer be restricted from applying for jobs in other firms in the industry if they quit or are fired. The upward shift of the PS curve reflects the lower markdown firms will be able to impose on workers, with the result that the real wage will go up.

The effect on employment is ambiguous—on the one hand, firms will hire more (there is less profit incentive to restrict employment) but on the other hand, firms are less profitable so some may go bankrupt. In a diagram, the effect on employment depends on the relative size of the upward shift in the PS and in the WS.

Disequilibrium: The WS–PS model in motion

Analysing what happens when the economy is not at equilibrium often helps us to understand how a model works.

Employment higher than equilibrium

In Figure 1.24, the equilibrium is at point A. To the right of point A, a higher real wage has to be paid to recruit and motivate workers than is consistent with profit maximization by firms given the extent of competition in the market. Since the gap between the labour productivity dashed line and the PS curve measures profits per worker, if the wage goes up to the level shown by the WS curve at employment, N_B (w_B), profits per worker would shrink. This will not be profit maximizing for firms and since competition has not changed and production has become more costly, firms will raise their prices and reduce output and employment. The economy will move towards the equilibrium at point A.

Fullscreen

https://www.core-econ.org/macroeconomics/01-supply-side-macroeconomy-08-ws-ps-equilibrium.html#figure-1-24

Figure 1.24 The WS–PS model, case 1: employment above equilibrium.

Employment lower than equilibrium

To the left of point A (for example, point C in Figure 1.25), firms would realise that they could lower the wage to w_C and still get the workers and effort needed. Now, making higher profits, they would want to produce more. To sell more, they would reduce prices. The economy would move toward point A with both employment and real wages rising.

Fullscreen

https://www.core-econ.org/macroeconomics/01-supply-side-macroeconomy-08-ws-ps-equilibrium.html#figure-1-25

Figure 1.25 The WS–PS model, case 2: employment below equilibrium.