The Micro Model

Abstract

In this section we discuss the connections between demand, supply and actual transactions at the level of single micro goods and labor markets. This ‘micro model’ will serve then in section 3 as starting point for the derivation of macroeconomic relationships by adopting a “smoothing-by-aggregation” technique. Generally speaking, goods and labor markets are linked through (a) firms’ decisions on goods supply and labor demand, (b) households’ decisions on goods demand and labor supply. When prices and wages adjust too slowly to clear markets in the period under consideration, these decisions are subject to quantity rationing and may involve spillover effects, so that a distinction between ‘notional’ and ‘effective’ trade offers becomes necessary. We focus our analysis on link (a), taking thus into account that firms rationed in labor demand curtail effective output supply and that firms facing a ‘sales constraint’ react by reducing effective labor demand. Spillovers in the household sector, although theoretically substantiated in an analogous manner, seem less relevant in practice:

• In Western industrialized countries, and in particular in a small open economy like Switzerland where a large part of consumption goods is imported, it seems unlikely that households get ever rationed in goods demand to an extent that induces them to reduce labor supply. Therefore, we need not distinguish between notional and effective labor supply.

• The spillover from involuntary unemployment to consumption demand, even though dampened by unemployment benefits, is surely more important. It is however only demand for domestically produced consumption goods, representing a rather small part of total sales, that is relevant to the output and employment decision of domestic firms. Furthermore, the spillover in question can be accounted for, without an explicit distinction between notional and effective demand, by means of a traditional Keynesian consumption function with realized income as explanatory variable.¹