The Labor Market Slide #1Econ 302
The Labor Market: The Medium RunThe Labor Market: The Medium Run
Higher production requires an increase in employment
Higher employment reduces unemployment
Lower unemployment puts pressure on wages
Higher wages increase production costs and therefore prices
A Medium Run Response to an Increase in DemandA Medium Run Response to an Increase in Demand
The Labor Market Slide #2Econ 302
The Labor Market: The Medium RunThe Labor Market: The Medium Run
Higher prices lead workers to ask for higher wages….
Prices and wages (the labor market) adjust over the medium run and influence output
A Medium Run Response to an Increase in DemandA Medium Run Response to an Increase in Demand
The Labor Market Slide #3Econ 302
The Labor Market: The Medium RunThe Labor Market: The Medium Run
Employment93.8 million
Unemployment6.5 million
Out of laborforce
57.3 million
1.0
0.8
1.6
1.51.3
1.6
Interpreting the Labor Force DataInterpreting the Labor Force Data
The Labor Market Slide #4Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Large Flow of WorkersThe Large Flow of Workers
Observations: 1. (Continued)
•Half of the flows from employment are quits•Half of the flows from employment are layoffs
1. The size of the flows into and out of employment
The Labor Market Slide #5Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Large Flow of WorkersThe Large Flow of Workers
Observations:
•Average monthly flow out of unemployment is 2.4 million
•1.6 million to employment•0.8 million to out of the labor force
•Duration of unemployment is 3 months
2. The size of the flows into and out of unemploymentin relation to the total number of unemployed
The Labor Market Slide #6Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Large Flow of WorkersThe Large Flow of Workers
Observations:
•Each month:•350,000 new people enter•200,000 retire
•The aggregate flow indicates that many people move back and forth from participants to non-participants
3. The size of the flows into and out of the laborforce
The Labor Market Slide #7Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Differences Across WorkersDifferences Across Workers
Monthly Separation Rates for Different Groups, 1968-1986
Category
Male: Ages 16-19 35-44
Female: Ages 16-19 35-44
Monthly Separation Rate (%)(Quits and Layoffs)
15.91.6
16.15.0
The Labor Market Slide #8Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Movements in UnemploymentMovements in Unemployment
To Summarize:To Summarize:
High Unemployment:
• Increases the probability of workers losing their jobs•Reduces the probability of the unemployed finding a job• Increases the duration of unemployment
The Labor Market Slide #9Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Wage DeterminationWage Determination
Two Observations:Two Observations:
1. Workers’ wages exceed theirreservation wage
2. Wages depend on labor-marketconditions
The Labor Market Slide #10Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Bargaining power depends on:Bargaining power depends on:
1. How easily can a worker be replaced.
2. How easily a worker can find anotherjob.
Wage DeterminationWage Determination
The Labor Market Slide #11Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Efficiency Wages:Efficiency Wages:
Wages above the reservation wage thatincrease productivity and reduce theturnover rate.
Wage DeterminationWage Determination
The Labor Market Slide #12Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Wages and UnemploymentWages and Unemployment
Wage determination:Wage determination:
),(
),(
zuFPW e
W = WagePe = Expected price levelu = The unemployment ratez = Other variables that affect the wage setting
The Labor Market Slide #13Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The expected price level, Pe & wagesThe expected price level, Pe & wages
Wages and Unemployment:Wages and Unemployment:
),(
),(
zuFPW e
•Workers base their wage request on the purchasing power of their wages or real wage W/P
•Employers base the wage they pay on the price of the product they sell or the real wage W/P
•Therefore, if Price (P) increases, wages (W) increase
The Labor Market Slide #14Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Wages and Unemployment:Wages and Unemployment:
),(
),(
zuFPW e
• Higher unemployment reduces bargaining power and wages
• Higher unemployment reduces the efficiency wage
The unemployment rate, and wagesThe unemployment rate, and wagesu
The Labor Market Slide #15Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Wages and Unemployment:Wages and Unemployment:
),(
),(
zuFPW e
• Unemployment insurance: higher benefits leads to higher wages
• Structural Economic Change: wages increase when jobs created exceed jobs destroyed
The other factors and wagesThe other factors and wages)(z
The Labor Market Slide #16Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Price Determination and the Production FunctionPrice Determination and the Production Function
Assume labor is the only input, thenAssume labor is the only input, then
Output (Y) = ANN = EmploymentA = Labor Productivity
Assume A=1Y = N
If Y=N: then marginal cost = Wage (W)
The Labor Market Slide #17Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Price Determination and the Production FunctionPrice Determination and the Production Function
When perfect competition exists in the product marketWhen perfect competition exists in the product market
Price (P) = Marginal CostGiven: Marginal cost = WThen: P=W
In non-competitive markets P=(1+µ)W
µ= Markup of price over cost
The Labor Market Slide #18Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The wage-setting relationThe wage-setting relation
Assume: Pe = PW=PF(u,z) and dividing by P
),( zuFP
W
),(
The higher the unemployment rate (u), the lowerthe rate wage
P
W
The Labor Market Slide #19Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The wage-setting relation:The wage-setting relation: ),( zuFP
W
),(
WS
Unemployment Rate, u
Rea
l W
age,
W/P
Wage-setting relation(W/P varies inversely with u)
The Labor Market Slide #20Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The Price-setting relation:The Price-setting relation:
Recall: μP
W
1
1
Observe: • If markup (µ) increases
• Price (P) increases, given wages (W)
• Real wage falls
• Price setting a function of markup (µ)
The Labor Market Slide #21Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The Price-setting relation:The Price-setting relation:
1
1
P
W
PS
Price-setting relation(W/P is independent of u)
Unemployment Rate, u
Rea
l W
age,
W/P
1
1
The Labor Market Slide #22Econ 302
Unemployment Rate, u
Rea
l W
age,
W/P
un – The natural rate of unemployment
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
Equilibrium Real Wages, Employment and UnemploymentEquilibrium Real Wages, Employment and Unemployment
Labor Market Equilibrium
WS
1
1PS
Wage-setting, F(u, Z) = Price-setting, 1
1
A
The Labor Market Slide #23Econ 302
WS´ = F(u, Z´)
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
Is the natural rate of unemployment “natural”?Scenario: Increase unemployment benefits (z increases)Is the natural rate of unemployment “natural”?Scenario: Increase unemployment benefits (z increases)
Unemployment Rate, u
Rea
l W
age,
W/P
WS = F(u, Z)
1
1PS
un
A B
un´
The increase in Z increases un
The Labor Market Slide #24Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
Scenario: More stringent antitrust legislation (µ decreases)Scenario: More stringent antitrust legislation (µ decreases)R
eal
Wag
e, W
/P
WS = F(u, Z)1
1PS
unun´
The decrease in u reduces un
´1
1
PS´
Unemployment Rate, u
The Labor Market Slide #25Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
From Unemployment to OutputFrom Unemployment to Output
The Natural Level of EmploymentU = unemploymentN = employmentL = labor forceu = unemployment rate
L
N
L
NL
L
Uu
1
Rearranging for N: N=L(1-u)
The Labor Market Slide #26Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
From Unemployment to OutputFrom Unemployment to Output
The Natural Level of Employment
N=L(1-u)un = natural rate of unemploymentNn = natural level of employmentNn = L(1-un)
The Labor Market Slide #27Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
From Unemployment to OutputFrom Unemployment to Output
The Natural Level of Output
Y = NYn = Nn = L(1-un)Y = NYn = Nn = L(1-un)
Assuming the Production Function:
Assuming the Production Function:
The Labor Market Slide #28Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
From Unemployment to OutputFrom Unemployment to Output
Equilibrium Unemployment Rate:
1
1),( zuF n
Natural level of output: )1()( nn uLY
1
1),1( z
L
YF n
1
1),1( z
L
YF n
The Labor Market Slide #29Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Equilibrium Real Wages, Employment, and UnemploymentEquilibrium Real Wages, Employment, and Unemployment
At Yn the associatedLY
un
n /
1
and the real wage chosen in wage settingequals the real wage implied by price setting.
The Labor Market Slide #30Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
A SummaryA Summary
Assume: The expected price = actual price level
Then: • Wage setting implies the real wage is inversely related to unemployment
•The price setting real wage is constant
•Labor market equilibrium occurs when W/P wage setting = W/P price setting
•Labor market equilibrium determines the unemployment rate – the natural rate of unemployment
• Wage setting implies the real wage is inversely related to unemployment
•The price setting real wage is constant
•Labor market equilibrium occurs when W/P wage setting = W/P price setting
•Labor market equilibrium determines the unemployment rate – the natural rate of unemployment
The Labor Market Slide #31Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Where We Go From HereWhere We Go From Here
Recall: • Labor market equilibrium determines the natural level of unemployment which determines the natural level of output
• Labor market equilibrium determines the natural level of unemployment which determines the natural level of output
Observe: • Monetary policy, fiscal policy, consumer confidence does not impact the natural level of unemployment and output
• Monetary policy, fiscal policy, consumer confidence does not impact the natural level of unemployment and output
The Labor Market Slide #32Econ 302
A Tour of the Labor MarketA Tour of the Labor Market
Where We Go From HereWhere We Go From Here
Short-Run • Price level may not equal the expected price
• Unemployment may equal natural unemployment level
• Output may equal natural output
• Price level may not equal the expected price
• Unemployment may equal natural unemployment level
• Output may equal natural output
Medium-Term
• Price level tends to equal expected prices
•Unemployment tends to the natural rate
•Output moves toward the natural rate
• Price level tends to equal expected prices
•Unemployment tends to the natural rate
•Output moves toward the natural rate
The Appropriate Time FrameThe Appropriate Time Frame