1

The Labor Market: Wages … Prices … Wages

• Higher production requires an increase in employment

• Higher employment reduces unemployment

• Lower unemployment puts pressure on wages

• Higher wages increase production costs and prices

• Higher prices lead workers to ask for higher wages….

• Prices and wages (the labor market) adjust over the medium run and influence output

Medium Run Response to an Increase in DemandMedium Run Response to an Increase in Demand

Employment Status of the Population

2006 Jan-09 2009 (year)

Total Population 301 306 307

Less: Under 16

Military 73 71 71Institutionalized (Jail,

Hospital) ____ ____ _____Non-institutionalized civilian population 228 235 236

Less: Not working or looking

Retired

Home - workers

Full-time students 77 81 82

Idle rich

Discouraged workers ____ ____ _____

Civilian labor force 151 154 154

Employed 144 142 140

Unemployed 7 12 14

Participation rate = Laborforce/Non-inst. Population 66.4% 65.5% 65.4%

Unemployment rate

=Unemployed/Labor force 4.6% 7.6% 9.3%

Discouraged workers 381,000 734,000

Percent of labor force 0.25% 0.48%

3

The Labor Market: The Medium Run

A Tour of the Labor MarketA Tour of the Labor Market

)2003(%3.662.221

6.146

PopulationtionalNoninstitu

ForceLabor

The participation rate=

The unemployment rate =The unemployment rate =

)2003(%0.65.146

8.8

ForceLabor

Unemployed

4

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)Labor Force Data, 1994 – 1999 (monthly flows)Separation rate = (2.8+1.8+2.8)/122 = 6%per month

Labor Market Monthly Flows, 1996 – 2003

Population leaving labor force/month= (2.8 + 1.4)/(122 +59.3) = 2.3 %

Unemployed finding work= 1.4/6.2 = 23% /mo.

Unemployed leaving unemployment each month = (1.4+1.4)/6.2 = 45%Avg duratation of unemployment = 1/.45 = 2.2 months

5

6

7

Movements in UnemploymentMovements 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

Differences Across WorkersDifferences Across Workers

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

Wage DeterminationWage Determination

1.Workers’ wages exceed their reservation wage

2. Wages depend on labor-market conditions:

•How easily can a worker be replaced?•How easily a worker can find another job?

•Efficiency Wages: Wages above the reservation wage• Increase productivity

•Morale up•Shirking down•Monitoring costs down

•Reduce turnover rate.•Reduce hiring costs.

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 expected price level, Pe & wagesThe expected price level, Pe & wages

Wage Setting Behavior:Wage Setting Behavior:),(

),(

zuFPW e

•Workers base their wage request on the purchasing power of their wages or real wage they expect, W/Pe

•Employers base the wage they pay on the expected price of the product they sell or the real wage, W/Pe

If Expected Price (Pe) increases, wages (W) increaseThe unemployment rate, and wagesThe unemployment rate, and wagesu

• Higher unemployment reduces bargaining power of labor wages decline with u, other things equal• Higher unemployment reduces the efficiency wageThe other factors and wagesThe other factors and wages)(z• Unemployment insurance: higher benefits higher wages• Structural Economic Change: …wages increase when jobs created exceed jobs destroyed

Price Determination and the Production FunctionPrice Determination and the Production FunctionAssume 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)

In non-competitive markets: P = (1+µ) W

µ= Markup of price over cost

1

1

P

W If markup (µ) increases

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

• Real wage falls

The wage-setting relationThe wage-setting relation

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

),( zuFP

W

),(

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

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 Price-setting relation:The Price-setting relation:

1

1

P

W

Unemployment Rate, u

Rea

l W

age,

W/P

1

1PS

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

Unemployment Rate, u

Rea

l W

age,

W/P

un – The natural rate of unemployment

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

Labor Market Equilibrium

WS

1

1PS

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

1

1

A

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.

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)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

Scenario: More stringent antitrust legislation (µ decreases)Scenario: More stringent antitrust legislation (µ decreases)

Rea

l W

age,

W/P

WS = F(u, Z)1

1PS

unun´

The decrease in µ reduces un

´1

1

PS´

Unemployment Rate, u

From Unemployment to OutputFrom Unemployment to Output

U = unemploymentN = employmentL = labor forceu = unemployment rate

L

N

L

NL

L

Uu

1

•As output (Y) and employment (N) increase, the unemployment rate declines.•As output (Y) increases, the real wage set by wage setters (W/P) increases.•A “natural” or full employment level of output (Yn) corresponds to the “natural” rate of unemployment (un)

Rea

l W

age,

W/P

Output, Y

1

1PS

WS

Yn

Equilibrium, Structural, or “Natural” Rate of Output

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

• Unemployment may not equal natural unemployment level

• Output may not equal natural output

• 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

• 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