11

The Labor MarketThe Labor Market: Wages … Prices … Wages: Wages … Prices … Wages

Higher production requires an increase in Higher production requires an increase in employmentemploymentHigher employment reduces unemploymentHigher employment reduces unemploymentLower unemployment puts pressure on wagesLower unemployment puts pressure on wagesHigher wages increase production costs and Higher wages increase production costs and pricespricesHigher prices lead workers to ask for higher Higher prices lead workers to ask for higher wages….wages….Prices and wages (the labor market) adjust Prices and wages (the labor market) adjust over the medium run and influence outputover the medium run and influence output

Medium Run Response to an Increase in Demand

22

The Labor Market: The Medium RunThe Labor Market: The Medium Run

A Tour of the Labor Market

U.S. Population 2003 291.0 million Minus: Pop. under 16, -69.8 million Armed forces and

Incarcerated

Civilian Noninstitutional Pop. 221.2 million Civilian Labor Force 146.5 million Employed 137.7 million Unemployed 8.8 millionOut of the Labor Force 74.7 million

33

The Labor Market: The Medium RunThe Labor Market: The Medium Run

A Tour of the Labor Market

)2003(%3.662.2216.146

PopulationtionalNoninstitu

ForceLaborThe participation rate=

The unemployment rate =The unemployment rate =

)2003(%0.65.146

8.8

ForceLaborUnemployed

44

The Labor Market: The Medium RunThe Labor Market: The Medium Run

Employment127 million

Job Change3.5 million

Unemployment7.0 million

Out of laborforce

66.7 million

1.1

1.3

1.7

1.51.5

1.8

Labor Force Data, 1994 – 1999 (monthly flows)

55

A Tour of the Labor MarketA Tour of the Labor Market

Differences 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

66

Movements in Unemployment

77

88

99

Movements in Unemployment

High Unemployment:•Increases the probability of workers losing their jobs•Reduces the probability of the unemployed finding a job•Increases the duration of unemployment

1010

Wage Determination

1. Workers’ wages exceed theirreservation wage

2. Wages depend on labor-marketconditions:•How easily can a worker be replaced?•How easily a worker can find another job?

•Efficiency Wages: Wages above the reservation wage that increase productivity and reduce the turnover rate.

1111

Wages and Unemployment

Wage determination:

),(),(

zuFPW e

W = WagePe = Expected price levelu = The unemployment ratez = Other variables that affect the wage setting

1212

The expected price level, Pe & wages

Wage Setting Behavior:

),(),(

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 unemployment rate, and wagesu

• Higher unemployment reduces bargaining power of labor and wages• Higher unemployment reduces the efficiency wage

The other factors and wages)(z• Unemployment insurance: higher benefits higher wages• Structural Economic Change: wages increase when jobs created exceed jobs destroyed

1313

Price Determination and the Production FunctionAssume labor is the only input, then

Output (Y) = ANN = EmploymentA = Labor Productivity

Assume A=1Y = N

If Y=N: then marginal cost = Wage (W)In non-competitive markets:

P=(1+µ)W µ= Markup of price over cost

11

PW If markup (µ) increases

• Price (P) increases, given wages (W)

• Real wage falls

1414

The wage-setting relation

Pe = P in medium run, soW =P F(u,z)

),( zuFPW

),(

The higher the unemployment rate (u), the lowerthe real wage

PW

1515

The wage-setting relation:

),( zuFPW

),(

WS

Unemployment Rate, u

Rea

l Wag

e, W

/P

Wage-setting relation(W/P varies inversely with u)

The Price-setting relation:

1

1PW

Unemployment Rate, u

Rea

l Wag

e, W

/P

11

PS

Price-setting relation(W/P is independent of u)

1616

Unemployment Rate, u

Rea

l Wag

e, W

/P

un – The natural rate of unemployment

Natural Rate of Unemployment …Structural Rate … Equilibrium Rate … NAIRU

Equilibrium Real Wages, Employment and Unemployment

Labor Market Equilibrium

WS

11

PS

Wage-setting, F(u, Z) = Price-setting,

11

A

1717

WS´ = F(u, Z´)

The Natural Rate of Unemployment / Structural Rate of Unemployment

= The unemployment rate at which wage-setters accept the real wage they must accept, given markup μ.

Is the natural rate of unemployment “natural”?Scenario: Increase unemployment benefits (z increases)

Unemployment Rate, u

Rea

l Wag

e, W

/P

WS = F(u, Z)

11

PS

un

A B

un´The increase in Z increases un

1818

The Natural Rate of Unemployment

Scenario: More stringent antitrust legislation (µ decreases)

Rea

l Wag

e, W

/P

WS = F(u, Z)1

1PS

un un´The decrease in µ reduces un

´11 PS´

Unemployment Rate, u

1919

From Unemployment to Output

U = unemploymentN = employmentL = labor forceu = unemployment rate

LN

LNL

LUu

1

Rearranging for N: N=L(1-u)The Natural Level of Employment

N=L(1-u)un = natural rate of unemploymentNn = natural level of employmentNn = L(1-un)

2020

From Unemployment to Output

Equilibrium Unemployment Rate:

1

1),( zuF n

Natural level of output: )1()( nn uLY

11),1( z

LYF n

2121

Equilibrium Real Wages, Employment, and Unemployment

At Yn the associated

LYu

nn /

1

and the real wage chosen in wage settingequals the real wage implied by price setting.

2222

Short-Run • Price level may not equal the expected price

• Unemployment may not equal natural unemployment level

• Output may not equal natural output

Medium-Term

• Price level tends to equal expected prices

•Unemployment tends to the natural rate

•Output moves toward the natural rate

The Appropriate Time Frame