MacroEconomics Notes

Unit 9

Labour Market
Introduction
- We assume firms have power and can set their own prices
- Price is set by marketing department (in this theory)
- Inverse relationship between unemployment and real wage

How to measure key variables

- Unemployed people are not in paid employment or self-employment, are available for
work(excludes students) and are actively seeking for work

Labour Market Statistics

- Participation rate= (labour force)/(pop of working age)
- Unemployment rate= (unemployed) / (labour force)
- Employment rate= (employed) / (population of working age)

Types of unemployment
Frictional Unemployment
- Individuals between jobs with skills and will likely find work

Cyclical Unemployment
- Seasonal and relates to business cycle
- During economic downturn certain sectors will face unemployment but when market
recovers they will be employed
Structural Unemployment
- Mismatch between skills available and skills required by firms

Price Setting and Wage Setting

- Real wage= wage / price
- Each firm decides on price, wage and how many people to hire
- Adding up across all firms give total employment in the economy and real wage
- HR determines lowest wage for enough effort -> MD sets price for product ->
Production decides how many workers are needed

-Current unemployment is 12% (Point A) Which is at equilibrium for LD

- If unemployment drops to 5% (Point B) The decrease in unemployment increases
bargaining power amongst unemployed labourers. Increase in Bargaining power results in
increase in reservation wage (BRF shift to the right resulting in higher wage leading to higher
point on wage-setting curve.

- Wage setting curve shows the real wage necessary at each level of economy-wide
employment to provide workers with incentives
Shifts in the wage-setting curve:
- Change in reservation Wage -> movement along the wage-setting curve
- Change in employment rent -> shifts the wage setting-curve
- Anything that leads to change in effort levels for the same wage leads to a shift of the
wage-setting curve. Increase in effort leads to a downwards shift of wage-setting.

Profit-Maximising Price
- Optimal price lies where the demand curve is tangent to isoprofit curve.
- The firm then hires a number of employees necessary to produce quantity of output
at demanded price

Distribution of Output
- Price = (profit/Output) + (Wage/Output)
- Profit-maximising price also determines firms optimal markup
- Output per worker = average product of labour
- Real profit is average product of labour taken home by the owners
- Real wage is the proportion of APL taken home by the workers
- APL=Real Profit + Real Wage

Determining Price-Setting Curve

- μ - markup
- λ - APL
- W - nominal wage
 - P - Price
- MC - Marginal Cost

- μ = (P-MC)/P -> MC=AC if wages are only cost of prod

- μ = (P-AC)/P = (P-W/λ)/P = 1-W/λP)
- W/p = λ-λμ
- Real wage is the amount of production leftover once the owners of
the resources take their profit
- The gives a number which means Price-setting is horizontal
depending on markup and APL
- Price setting curve depends on competition which will affect markup
and what owners take home will change, labour productivity
determines real wage for a given markup, for LP real wage changes
but proportion of output by owners does not change
- Profit maximising price at equilibrium(highest isoprofit) gives best
price and units to sell goods for. The price from Profit-maximising
gives a price for wage-setting.

Labour Market Equilibrium

- Nash equilibrium of labour market is where wage-setting and price-setting curves

intersect
- All parties in labour market will perform given:
- -- firms are offering least wage to ensure effort
- -- employment is highest it can be given wage
- -- those who have jobs cannot improve their situation by asking for higher pay or less
effort
- -- unemployed want to work but cant get hired by accepting lower wage

Involuntary Unemployment
- Unemployment is excess supply in the labour market
- Always be unemployment in labour market equilibrium
- No unemployment-> no cost of job loss->no effort exerted
- Unemployment threat is necessary for motivation

Unemployment and Aggregate Demand

- Firms demand for labour depends on demand of the firms goods/service
- Aggregate demand = sum of demand for all goods and services produced in the
economy
 - Increase in unemployment caused by fall in aggregate demand is demand-deficient
unemployment

Demand-Deficient Unemployment
- Low aggregate demand leads to higher unemployment

- Firms now at point B:

- - firms could lower wages lead to lower prices to stimulate demand and lead to output
rising leading to firm hiring more workers and return back to equilibrium
- This doesn't always work in the real world and workers won't just accept a lower
wage because demand is lowered. Lower wages will also mean people spend less
and aggregate demand decreases. Falling prices may lead consumers to postpone
purchases in hopes of a better deal later.

Government Intervention
- Government could increase its own spending to increase aggregate demand

Labour Supply
- Increase in labour supply shifts wage-setting downwards
- - more unemployed so longer expected time in unemployment leading to higher
employment rent and lower cost of effort

Division Of Output
- Gini coefficient determines inequality in the economy
- Gini coefficient formula = u+ n - (1-u)(W/q)
- -- u - fraction of unemployed
 - -- n - fraction of employed
- -- w - is real wage
- -- q - APL

Labour Unions
- Organisation consisting of predominantly employees
- Main activities include the negotiation of rates of pay and conditions of employment
for its members

Wage Bargaining
- Unions negotiate wages with firms
- Union can threaten to strike if demands are not met.
- High bargaining power for unions would shift the new WS curve higher. This
increases unemployment similarly to decrease in aggregate demand
- This doesn't necessarily translate to real world
- Providing workers with a voice induces them to exert higher effort for same wage
- Unionisation lifts the wage setting curve but union voice effect may drop it back down
due to increase effort per wage
- Effect of labour unions is ambiguous

Labour Market Politics

- Education and Training increases labour productivity shifting the price setting curve
up whereas wage subsidy shift production down as firms costs decrease causing
price to decrease
- Change in unemployment benefits change reservation wage and shifts wage-settin
- Immigration policies can either increase or decrease labour supply

Unit 10
Money and Wealth
- Money - medium of exchange used to purchase goods or services
- Function of money - store value, unit of account and medium of exchange
- Money allows purchasing power to be transferred among people
- Commodity money is from natural resources
- Fiat money gets its value from a government and is declared as legal tender as must
be accepted as a means of payment
- Fiduciary money is not legal tender and not required by law to be accepted
- Barter economy needs double coincidence of wants
- Money serves as an intermediary for exchange process, it is a medium
- Money is a unit of account of common measure
 - Money can lose some usefulness due to inflation
- Money can be kept to exchange at a later stage
- Wealth - stock of things owned or value of that sock
- Income - amount of money received over some period of time
- Depreciation - reduction in the value of stock over time
- Net income- maximum amount one could consume without running down wealth
- NI = Gross Income - Dep
- Earnings - Income from labour
- Savings - income not consumed
- Investment - Expenditure on newly produced capital goods

Central Bank
- Only bank that can create legal tender
- Usually owned by government
- Banker for commercial banks
- South African Reserve Bank
- - regulates depository institutions and controls the quantity of money
- SARB is independent of government
- Primary goal of SARB - achieve and maintain price stability in the interest of
balanced and sustainable economic growth
- SARB is responsible for: formulating and implementing monetary policy
- - Ensuring a sound money, banking and financial system of SA
- - Assisting in implementation of macro policy
- - Informing public about monetary policy and economic situation in SA

Demand for Money

- Shows the inverse relationship between quantity demanded of money and price of
holding money

- Change in
nominal
 interest rates causes slide along the curve
- Increase in demand(upwards shift) is caused by increase in real gdp and increase in
price level
- Decrease demand caused by decrease in real gdp and price level
- Financial innovation (crypto) causes decrease in demand

Borrowing Money
- Allows us to buy more now at cost of buying less later
- Interest price - price of bringing buying power forward in time
- (1+r) - interest formula - price of bringing buying power forward in time - is the MRT
- FV=PV(1+r) - all points on FF must satisfy this equation

Consumption Preference
- Consumption smoothing - diminishing marginal returns to consumption
- Pure impatience - value current consumption more than future consumption
- -- Myopia (short-sightedness) - people experience present satisfaction
- -- Prudence - People know that they may not be around in the future

Consumption Smoothing
- Consumer has fixed amount of money
- Spends money of only two normal goods
- Prices of two goods are constant
- More is better applies
- DMR to consumption
- Individual smooths consumption to avoid consuming a lot in one period and little in
another
MRS and Indifference Curve
- MRS represents slope of indifference curve and shows rate at which we will sacrifice
consumption now and consumption later

- At E, Julia is willing to give up more consumption now for consumption in the future
- At C, future consumption is high in the future
- Diminishing marginal returns is applied in both time periods
- MRS changes along the indifference curve
- Optimisation along highest indifference curve
- Equilibrium at MRT=MRS=(1+r)=(1+p)

Borrowers and Savers

- Borrowers and savers have different indifference curves because they have different
endowments
- Reservation indifference curves - all points a which an individual would be just as
well off as at the endowment
- Savers smooth consumption by postponing it to the future
- Lending money at interest expands savers feasible frontier
- Investment is another way to move consumption to the future
- Combination of investing and borrowing can lead to increase in consumption in both
periods
Summary of Scenarios

- If an individual had pure impatience their indifference curve(MRS) is greater than 1

- If an individual had no pure impatience they would have and MRS of 1
Assets Liabilities and Net Worth
- Balance sheet summarises what a household or firms owns and what it owes
- Assets - anything of value that is owned
- Liabilities - Anything of value that is owed
- Net Worth = Asset-Liabilities

Banks, Money and Central Bank

- Bank makes profit by lending and borrowing
- Banks borrow deposits, from other banks and the central banks
- Interest they pay on deposits is lower and interest they charge on loans is higher

SARB Creating Money

- Controls the level of base money in the economy
- Acts as a banker for commercial banks who have accounts at the central bank that
hold legal tender
- By providing more high-powered money SARB can dictate how much money is in
circulation - not by printing money but by increasing commercial banks reserves
- As reserves increase banks can provide more loans to households and high-powered
money increases in the economy

High-Powered Money vs Bank Money

- Commercial banks create money by creating loans
- This is a liability to the bank
Default Risk and Liquidity
- Banks provide service of Maturity Transformation:
- Banks us customer deposits to create loans for other customers
- Deposits can be withdrawn at any time but loans only need to be repaid at a specific
time
- Banks take short-term deposits and take long-term loans

- Liquidity risk - risk an asset cannot be exchanged for cash rapidly enough to prevent
financial loss
- Default risk - risk that credit given as loans will not be repaid

Banking Crisis
- Banks make money by lending more than they have in legal tender
- Bank run - all depositors demand their money at once possibly resulting in bank
failure
- Banks can also fail by making bad investments,(loans not getting repaid)
- Government may intervene as a banking crisis may bring down the financial system

Money Market
- Banks need enough base money to cover their net transactions
- Banks borrow on the money market when they do not have sufficient base money to
transfer from a customer to another
- Demand for base money depends how many transactions commercial banks have to
make

Financial System
- If a bank needs more base money than it has on hand the SARB will lend more at a
specified rate
- Other banks stick to this policy rate when moving money between themselves
- Lending rate - rate which public borrows can borrow from commercial bank
- Lending rate varies from customers depending on how risky an investment is
 - Policy interest rate - interest rate on base money set by central bank

Banking
- Banks costs are the cost of operating physical location(salaries, rent) and interest
cost on their liabilities
- Bank Revenues are interest and repayment of loans as well as investments
- Leverage is the reliance of a company on debt
- Higher leverage means lower net worth
- Leverage ratio of 10 means assets of a bank is 10x its net worth
- leverage= assets/net worth

Central Bank Policy Rate

- Affects the level of spending in the economy because households and firms borrow
to spend
- Higher interest rate = lower spending

Credit Rationing

Principal-Agent Problem
- As a lender (principal) risk that money will not be repaid, problematic when borrower
(agent) is using money for a project that requires effort on behalf of the borrower

Equity, Collateral and Lending

- To resolve conflict between lender and borrower lender may require the borrower to
put some equity into the project
- The borrower may also have to set aside property that will be transferred to the
lender if loan is not repaid
- Those with less wealth find it more difficult to provide equity or collateral
- Credit rationing - when those with less wealth borrow on unfavourable terms
compared to those with more wealth (credit-constrained)
- Some can also be refused loans(credit-excluded)
- Inequality may increase when some people are in position to profit by lending money
to others

Forex Market
- Demand for one currency is supply of another
- Quantity demanded of rand is amount that are willing to buy at a given point in time
given the price
Demand of FOREX
- People want rand to buy south african goods and services and invest
- Key determinants of demand are the exchange rate, demand for exports, interest
rates of the country vs other countries and future expected exchange rate
- Law of demand - higher the exchange rate (price) smaller quantity of rands
demanded
- Lower exchange rate means prices of goods are cheaper for stronger currencies and
demand for rands is higher to purchase more goods - Export Effect
- Expected Profit Effect - for a given expected future exchange rate the weaker the
currency is today the more profit you can potentially make in the future and more
rands you want to buy

- Demand CUrve for Rand

FOREX Supply
- South Africans want foreign currency to buy foreign goods and services and invest
- Determinants of Supply are exchange rate , SA demand for import, interest rate in
SA vs other countries, expected future exchange rate
- Law of Supply - stronger the exchange rate for rands the greater amount of rands
supplied
- Import effects - stronger exchange rate means foreign goods are cheaper and South
Africans can supply more Rands
 - Expected Profit Effect - for a given expected future exchange rate the stronger the
rand is today the less profit you can potentially make in the future and more rands
you want to sell

Equilibrium in FOREX
Shifts
- Increase in demand will move the curve upwards vice versa
- Increase in supply will move curve downwards vice versa

Exchange Rate Expectations

- Prime interest rates in South Africa is 7% (USA 2%)
- People don't invest in south african banks because the rand is expected to
depreciate against the dollar
- Purchasing Power Parity is how much the money you have can buy us

Nominal vs Real Exchange Rates

- Nominal - price of one currency in terms of another
- Real - price of SA goods and services relative to a foreign goods and services
- Real exchange rate = E(P1/P2)
- E - nominal exchange rate
- P - price in the country
- Effective Exchange Rate - represents a weighted average of exchange rate for a
countries major trading partners