ABSTRACT
The labor market does not operate in isolation; it interacts with goods markets and asset markets to determine three important macroeconomic variables: (1) the inflation rate, (2) the interest rate, and (3) the unemployment rate. The macroeconomic model to be presented in this chapter is not complicated and is to be found in almost any textbook in macroeconomics. In fact, it is based on the well-known IS-LM-AS relationships, with the only claimed novelty being the emphasis on the micro-foundations of labor-market transactions developed in the previous chapter. From the goods market, we derive the IS curve which shows combinations of income and the interest rate that keep unintended inventories from appearing. In the money market, equilibrium is maintained along the LM curve which is again a locus of points in income-interest-rate space. Finally, the labor market provides us with the aggregate-supply curve via a production function and the labor-use equation. The AS curve is a relationship between output or income and the rate of inflation. The economy is assumed to be closed to international transactions to maintain simplicity, but an open-economy version of the model could be developed by introducing these transactions in the goods or asset markets.1
