The Labor Market

1
Chapter 6

• The Labor Market
• The Medium Run

2
Chapter Topics

• A Tour of the Labor Market
• Movements in Unemployment
• Wage Determination
• Price Determination
• The Natural Rate of Unemployment
• Where we Go From Here

3
The Labor Market The Medium Run
A Medium Run Response to an Increase in Demand

• 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

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The Labor Market The Medium Run
A Medium Run Response to an Increase in Demand

• Higher prices lead workers to ask for higher
  wages.
• Prices and wages (the labor market) adjust over
  the medium run and influence output

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The Labor Market The Medium Run
A Tour of the Labor Market
U.S. Population 1998 270.2 million Minus
Pop. under 16, -65.0 million
Armed forces and Incarcerated Civilian
Noninstitutional Pop. 205.2 million Civilian
Labor Force 137.6 million
Employed 131.4 million Unemployed
6.2 million Out of the Labor Force 67.6 million
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The Labor Market The Medium Run
A Tour of the Labor Market
What has caused the participation rate to
increase over time?
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The Labor Market The Medium Run
A Tour of the Labor Market

• The unemployment rate

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The Labor Market The Medium Run
Interpreting the Labor Force Data
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A Tour of the Labor Market
The Large Flow of Workers
Observations
Average monthly flow into employment3.1
million 1.6 from unemployment 1.5 from out of
the labor force Average monthly flow out of
employment 2.9 million 1.3 million to
unemployment 1.6 million to out of the labor
force
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A Tour of the Labor Market
The Large Flow of Workers
Observations 1. (Continued)

• Half of the flows from employment are quits
• Half of the flows from employment are layoffs

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A Tour of the Labor Market
The 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

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A Tour of the Labor Market
The 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

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A Tour of the Labor Market
Differences Across Workers
Monthly Separation Rates for Different Groups,
1968-1986
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A Tour of the Labor Market
Differences Across Workers
1998 Unemployment Rate
U.S. 4.5 Males 16-19 16.2 African-Ameri
cans 8.9
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A Tour of the Labor Market
Differences Across Workers
Question
Does the variance in unemployment among different
groups of workers imply a dual labor market?
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A Tour of the Labor Market
Movements in Unemployment
Observation
Small upward trend in the unemployment rate

• 1950s 4.5
• 1960s 4.7
• 1970s 6.2
• 1980s 7.3
• 1990s 5.9

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A Tour of the Labor Market
Movements in Unemployment
Observation
The trend increase is dominated by large
fluctuations in the unemployment rate

• 1992 7.7 (recession 1990-91)
• 1982 9.7

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A Tour of the Labor Market
Movements in Unemployment
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

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A Tour of the Labor Market
Wage Determination
Two Observations
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A Tour of the Labor Market
Wage Determination
Bargaining power depends on
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A Tour of the Labor Market
Wage Determination
Efficiency Wages
Wages above the reservation wage thatincrease
productivity and reduce theturnover rate.
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A Tour of the Labor Market
Wages and Unemployment
W Wage Pe Expected price level u The
unemployment rate z Other variables that affect
the wage setting
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A Tour of the Labor Market
The expected price level, Pe wages

• 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

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A Tour of the Labor Market

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

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A Tour of the Labor Market

• Unemployment insurance higher benefits leads to
  higher wages
• Structural Economic Change wages increase when
  jobs created exceed jobs destroyed

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A Tour of the Labor Market
Price Determination and the Production Function
Assume labor is the only input, then
Output (Y) AN N Employment A Labor
Productivity Assume A1 Y N If YN then
marginal cost Wage (W)
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A Tour of the Labor Market
Price Determination and the Production Function
When perfect competition exists in the product
market
Price (P) Marginal Cost Given Marginal cost
W Then PW
In non-competitive markets P(iµ)W
µ Markup of price over cost
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A Tour of the Labor Market
The Natural Rate of Unemployment
The wage-setting relation
Assume Pe P WPF(u,z) and dividing by P
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A Tour of the Labor Market
The Natural Rate of Unemployment
The wage-setting relation
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A Tour of the Labor Market
The Natural Rate of Unemployment
The Price-setting relation
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A Tour of the Labor Market
The Natural Rate of Unemployment
The Price-setting relation
Recall
Observe

• If markup (µ) increases
• Price (P) increases, given wages (W)
• Real wage falls
• Price setting a function of markup (µ)

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A Tour of the Labor Market
The Natural Rate of Unemployment
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A Tour of the Labor Market
The Natural Rate of Unemployment
Equilibrium Real Wages, Employment and
Unemployment
Labor Market Equilibrium
un The natural rate of unemployment
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A Tour of the Labor Market
The Natural Rate of Unemployment
Is the natural rate of unemployment
natural? Scenario Increase unemployment
benefits (z increases)
Real Wage, W/P
Unemployment Rate, u
The increase in Z increases un
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A Tour of the Labor Market
The Natural Rate of Unemployment
Scenario More stringent antitrust legislation
(µ decreases)
Real Wage, W/P
Unemployment Rate, u
The decrease in u reduces un
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A Tour of the Labor Market
The Natural Rate of Unemployment
For Discussion
Would the structural rate of unemployment be a
better name for the equilibrium rate of
unemployment than the natural rate of
unemployment?
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A Tour of the Labor Market
The Natural Rate of Unemployment
From Unemployment to Output
Rearranging for N NL(1-u)
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A Tour of the Labor Market
The Natural Rate of Unemployment
From Unemployment to Output
The Natural Level of Employment
NL(1-u) un natural rate of unemployment Nn
natural level of employment Nn L(1-un)
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A Tour of the Labor Market
From Unemployment to Output
The Natural Level of Output
Y N Yn Nn L(1-un)
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A Tour of the Labor Market
From Unemployment to Output
Equilibrium Unemployment Rate
Natural level of output
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A Tour of the Labor Market
Equilibrium Real Wages, Employment, and
Unemployment
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A Tour of the Labor Market
A 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

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A Tour of the Labor Market
Where We Go From Here
44
A Tour of the Labor Market
Where We Go From Here
The Appropriate Time Frame
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End of Chapter

• The Labor Market
• The Medium Run