The Labour Market Academic year 2015/16 Introduction to Economics Augusto Ninni

The Labour Market

Academic year 2015/16Introduction to Economics

Augusto Ninni

Questions of the day• How does the labour market function?

• Why are some workers unemployed?

• What does the unemployment rate depend on?

What do we do today

•Quick review of the model of demand and supply (Part I - Microeconomics)

•Construction of the model WS-PS

•Determination of the equilibrium

•Analysis of the determinants of unemployment

Just some definitionsLabour force = employed + unemployed peopleEmployed = Within people that are at least 15 years old:1. People that have worked (even for a single hour) during the reference week even if self employed, or employed in a family business; 2.People that are employed but temporarily cannot work (illness, maternity leave, training, etc.);Unemployed = Within people that are at least 15-74 years old:1.Not employed people : has not worked a single hour during the reference period;2.Is available for work within 15 days 3.Is actively searching for employment.Inactive: 15-74 people, not employed neither unemployed peopleParticipation rate = Labour force / Population (referred to the age)

Employment rate = Employed / Population (referred to the age)Unemployment rate = Unemployment / Labour force

Demand and supply of labour

It is the simplest model to study the labour market

Remember: the opposite of the common language →

Enterprises “demand” labour

Households and workers “supply” labour

Firms “demand” labour -> the labour demand (DL) point out how many workers the firms want to hire at the market wage (W)

It follows that the higher the wage the lower the number of workers that the firms are willing to hire

DL is a decreasing function of the wage

Demand and supply of labour

Workers “supply” labour -> the supply of labour (SL) tells us how many workers are willing to work at the market wage (W)

It follows that the higher the wage the larger the number of workers that are willing to work

SL is an increasing function of wage

Demand and supply of labourIn equilibrium -> DL = SL -> Point E in the graph NE is the number of workers that are employed WE is the equilibrium wageW

N° workers

SL

DL

E

NE

WE

In equilibrium at E:•Along DL -> firms hire the number of workers that they wish•Along SL -> workers that wish to work are hired -> there is no unemployment

N° workers

SL

DL

E

NE

W

Demand and supply of labourIn real economies, however, there is unemployment

To explain the existence of unempl. -> WS-PS model

Construction of the WS-PS modelIn the WS-PS (wage setting – price setting) model :

•Firms fix the prices of the goods that are produced•Firms and workers negotiate on wages

Let’s examine them separately:

•Determination of wages•Determination of prices

The Wage Setting Equation

Determination of wages Individual negotiations

Branch agreements (Trade union negotiations)National legislations

Two main factors play a role:The reservation wage

The wage at which one is indifferent between working or remaining unemployed

Market conditionsThese determine the bargaining power of the employee.

• The bargaining power of a worker is a function of two factors:• The ease with which the firm can replace him

• This is linked to the skills of the worker and/or the job characteristics• The ease with which he can find another job

• This is linked to the level of unemployment

Construction of the WS-PS model

The determination of wages

Wage negotiation is explained by different theories

Summary of the main theories -> “wage setting” equation (WS)

W = PE F(u,z) - +

where W is the wage, PE is the expected prices, u is unemployment, and z is institutional variables of the labour market


Let’s examine the different components of this equation W = PE F(u,z)

a) W depends on P•Workers are not interested in the amount of money they receive but in the quantity of goods that they can buy with their wage ->•Workers are interested in the wage “in proportion” to the level of prices


b) In the equation we have PE rather than P

•Wages are negotiated ahead of time and remain fixed for a certain period of time so that the level of prices is not known with certainty ->

•Wages depends on “expected” prices -> PE (Important to distinguish between short and medium period)

c)F(u,z) -> W depends negatively on u• u -> Greater competition among workers ->

↓ Workers’ bargaining power -> ↓W


d)F(u,z) -> W depends also on institutional variables z (positive for convention)

The latter include:•The level of unemployment subsidies ↑ Subsidies -> ↑ Compensations requested to work•Minimum wage ↑ Minimum W -> ↑ Workers’ wage requests


Let’s go back to the WS equation -> W = PE F(u,z)

For the moment, let’s assume that price “expectations” are correct -> PE = P

In this case: WS -> W = P F(u,z)By rearranging we obtain

W/P represent the wage relative to the level of prices, i.e. the “real wage”

)z,u(FPW


Let’s draw the equation in a (W/P, u) diagram

F is decreasing in u -> the curve WS is decreasing

)z,u(FPW

WS (fixed z)

u

W/P


The determination of prices

Firms’ behaviour -> production

Two main simplifications:•Only one input -> labour (N) •The total product (Y) is equal to the amount of labour

that is employed -> Y = N

This implies that the cost to produce one unit of Y is equal to the cost to employ one worker, which is equal to the wage W


Let’s assume that firms fixe the price on the basis of the unitary cost of input following the rule:

Price= Unitary cost X + m

where 0< m is the mark-up.

Important: mis the % surcharge on costs

For instance, if m10% the price is equal to the costs increased by 10%


In our case the unitary cost is W so that: P = W (1+ m )

P = W(1+ m ) -> “Price setting” equation

Important: the dimension of mark up depends on the degree of competition among firms

m = 0 in case of perfect competition, it increases in cases of monopolistic competition and oligopoly

Construction of the WS-PS modelLet’s go back to equation PS -> P = W(1+ m )

P/W = 1 + m

W/P = 1 / (1+m)


We draw the PS in a (W/P, u) diagram

In the PS the real wage W/P does not depend on u -> the curve PS is an horizontal line

W/P

u

PS

The equilibrium in the labour market

We defined the two curves that describe the determination of wages (WS) and prices (PS)

Let’s now consider the two curves together in the same graph

We draw the two curves In E we are both on the WS and on the PS -> E is the equilibrium

In E there is unemployment -> u = un

un is the “natural” rate of unemployment

WS

u

W/P

PS

un

E

The determinants of unemployment

In the WS-PS model the system presents some positive degree of unemployment in equilibrium

This happens in because of two components of the model (that are absent in the standard supply and demand model):•Competition among firms is not perfect in the goods market•Presence of a wage negotiation mechanism


The equilibrium level of unemployment un depends on the same factors

In particular un is influenced by:The degree of competition among firmsThe institutional characteristics of the labour market

To understand these relationships let’s look at the effect on un of : ↓ competition among firmsChanges in the labour market legislation ( ↑ unemployment subsidies)

Let’s start from E and ↓ in competition

competition -> ↑ mark up m -> ↓ 1 /(1+m) -> PS shifts downward

Effects: E -> E’ and ↑ un

WS

u

W/P

PS

un

E

PS’E’

un’

Let’s start from E and ↑ subsidies ↑ subsidies -> ↑ z -> F(u,z) -> WS shifts upward

Effects: E -> E’ and ↑ un

WS

u

W/P

PS

un

E

WS’

un’

E’


The above results show that:• Competition among firms -> ↑ un

•Changes in the labour market legislation affects un (e.g. ↑ Unemployment subsidies -> ↑ un)

The rate of unemployment un depends on some structural factors (how market functions) -> for this reason is called “natural rate of unemployment”

Documents

The Labour Market Academic year 2015/16 Introduction to Economics Augusto Ninni