The Labor Market

Chapter 6

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6-1 A tour of the Labor Market

• Noninstitutional civilian population: Excluding those who are neither under worling age, in the armed forces, or behind bars, the number of people potentially available for civilian employment.

• Labor force: The sum of those either working or looking for work.

• Out of the labor force: Neither working in the market place nor looking for work.

• The participation rate: the ratio of the labor force to the noninstitutional civilian population.

• Unemployment rate: the ratio of the labor force to the number of unemployed.

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6-1 A tour of the Labor Market

• Seperations:1. Quits: Workers leave jobs for a better alternative.2. Lay-offs: due to changed in employment across

firms. Some firms suffer decreases in demand and decrease employment.

• Hires:• Duration of unemployment: The average length of

time people spend unemployed.• Discouraged workers: While they are not actively

looking for work, they will take one if they find one. • Non-employment rate: The ratio of population minus

employment to population.

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Focus: Henry Ford and Efficiency Wages

Table 1 Annual Turnover and Layoff Rates (%) at Ford, 1913–1915

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6-3 Wage Determination

• Collective Bargaining: bargaining between employers and unions (15% of workers in the US). It plays a more important role in Japan and in most European countries.

• Wages are set by employers (take-it-or-leave-it)or by bargaining between employers and individual employees.

• The higher the skills of the worker, there is more room for bargaining.

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6-3 Wage Determination

• Two common facts for wage determination1.Workers are paid a wage that exceeds their

reservation wage, the wage that would make them indifferent between being unemployed or working.

2.The lower the unemployment rate, the higher the wages.

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6-3 Wage Determination

Bargaining•Bargaining power of the worker depends on two factors:1.How costly it would be for the firm to replace him. 2.How hard it would be to find another job.

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6-3 Wage Determination

Efficiency wagesPaying above reservation wage makes it attractive for workers to stay. It increases productivity and decreases turnover rate. Efficiency wage theories link the efficiency or the productivity of workers to the wage. Like bargaining theory, these thories suggest that wages depend on both the nature of the job (high-tech firms pay more) and the labor market conditions.

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6-3 Wage Determination

• Both firms and workers care about real wages (W/P), not nominal wages.

• Wages depend on the expected price level (Pe) because actual prices are not yet known when they are set.

• Higher unemployment (u) weakens workers’ bargaining power.

The following equation will be used to capture the wage setting relation.

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6-3 Wage Determination

• A catchall variable z captures all the factors that affect wages, given u and Pe.

Some potential factors• unemployment insurance• minimum wage• employment protection

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6-4 Price Determination• The prices set by firms depend on costs.• Costs depend on the nature of the production function –the relation

between inputs and ouput produced- and the prices of inputs.• We assume that one worker produces 1 unit of output (output per

worker or labor productivity is 1).

• The marginal cost of production equals W.

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6-5 The Natural Rate of Unemployment

The Wage Setting Relation

The higher the unemployment rate, the lower the real wage.

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6-5 The Natural Rate of Unemployment

Dividing both sides of of the price-determination equation (6.3), by the nominal wage yields

Inverting both sides of equation (6.4) gives the implied real wage:

Price setting decisions determine the real wage paid by firms. An increase in the mark-up leads firms to increase their prices, given the wage; equivalently it leads to a decrease in the real wage.

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6-5 The Natural Rate of Unemployment

Figure 6-6 Wages, Prices, and the Natural Rate of Unemployment

The real wage implied by price setting is 1/1+m; it does not depend on the unemployment rate.

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6-5 The Natural Rate of UnemploymentEquilibrium Real Wages and Unemployment

Equilibrium in the labor market requires that the real wage chosen in the wage setting be equal to the real wage implied by price setting.

The “equilibrium unemployment rate is such that the real wage chosen in the wage setting is equal to the real wage implied by price setting, and is called the natural rate of unemployment.

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Equilibrium Real Wages and Unemployment

• The positions of WS and PS curves, and the equilibrium unemployment rate depend on z and .

• For example, a decrease in competition in the goods market (a increase in ) would shift the PS line up and raise the natural rate of unemployment.

• In words: An increase in the mark-up price, and accordingly an increase in the price leads to a decrease in the real wage. Higher unemployment is required to make workers accept this lower real wage, leading to an increase in the natural rate of unemployment.

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Equilibrium Real Wages and Unemployment

• An increase in the z index—say, because of an increase in unemployment benefits—would shift the WS curve up and increase the natural rate of unemployment.

• In words: At a given unemployment rate, higher unemployment benefits lead to higher real wage. A higher unemployment rate is needed to bring the real wage back to bring the real wage back.

• The word «natural» is misleading.

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6-5 The Natural Rate of Unemployment

Figure 6-7 Unemployment Benefits and the Natural Rate of Unemployment

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6-5 The Natural Rate of Unemployment

Figure 6-8 Markups and the Natural Rate of Unemployment

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6-5 The Natural Rate of UnemploymentFrom Unemployment to Employment

)1(

1

nn uLN

L

N

L

NL

L

Uu

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6-5 The Natural Rate of UnemploymentFrom Employment to Output

Using equation (6.2), Nn=(1-un)L implies a natural level of output Yn= Nn. Natural level of output satisfies the following equation:

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Summary

Assuming that expected price level is equal to the actual price level,•The real wage chosen in the wage setting (WS) is a decreasing function of the unemployment rate. •The real wage implied by price setting (PS) is constant. •Equilibrium in the labor market requires that the real wage implied by WS be equal to the real wage implied by PS.

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Summary

• This determines the equilibrium unemployment rate.

• This equilibrium unemployment rate is known as the natural rate of unemployment.

• Associated the natural rate of unemployment are a natural level employment and natural level of output.