Labour Market and Unemployment Overview

The Labour Market

• The labour market is central to understanding the medium-run adjustment of prices and wages, affecting output.
• Unemployment rate is the ratio of the unemployed to the labor force.
• An active labor market has many separations and hires.
• In a sclerotic labor market, there are few separations and hires, and a stagnant unemployment pool.
• Separations include quits and layoffs.
• The average duration of unemployment is the length of time people spend unemployed.

Unemployment Rate

• Unemployment rate can show either an active or sclerotic labor market.
• Discouraged workers aren't actively seeking work but would accept it if offered, and are counted as "out of the labor force."
• Economists sometimes focus on the employment rate (ratio of employment to the population) instead of the unemployment rate.

Wage Determination

• Wages are sometimes set by collective bargaining (between unions and firms).
• Slightly more than 10% of U.S. workers' wages are set this way.
• Higher skill jobs are more likely to have bargaining between employers and individual employees.
• Collective bargaining is significant in Japan and most European countries.
• Workers are usually paid above their reservation wage (the wage at which they are indifferent between working or being unemployed).
• Wages depend on labor market conditions; lower unemployment rates correlate with higher wages.
• Workers' bargaining power depends on the cost of firms finding new workers and how easily workers can find new jobs elsewhere.
• Efficiency wage theory links worker productivity to wages.
• Firms may pay above the reservation wage to reduce worker turnover and boost productivity.

Wage Determination

• The aggregate nominal wage (W) depends on the expected price level (Pe), unemployment rate (u), and a catch-all variable (z).
• W = Pe F(u, z) (-, +).
• Workers and firms focus on real wages (W/P), not nominal wages.
• Nominal wages depend on the expected price level, not the actual price level.

Wage Determination

• An increase in the unemployment rate typically leads to lower wages. This can either weaken workers' bargaining power or permit firms to pay lower wages.
• Factors (z) affecting wage determination include unemployment insurance and employment protection laws.

Price Determination

• Firm prices depend on costs and production function (Y = AN).
• Y is output, N is employment, and A is labor productivity (output per worker).
• Marginal cost of production is equal to the wage (W).
• Firms often set prices using a markup (m) over cost.
• P = (1 + m)W.

Wage Determination

• If the wage (W) depends on the actual price level (P) rather than the expected price level (Pe), then W/P = F(u, z).
• Higher the unemployment rate, lower the real wage chosen by wage setters.
• Price-setting relation: W/P = 1 / (1 + m)

Price Determination

• Dividing the price determination equation by the nominal wage gives the price-setting relation: W/P = 1 / (1 + m).
• Price-setting decisions directly affect the real wage paid by firms.

The Equilibrium Unemployment Rate

• Equilibrium unemployment rate (un) is derived by equating the wage-setting and price-setting relations.
• un depends on z and m.
• It's also known as the natural rate or structural rate of unemployment.

The Natural Rate of Unemployment

• The natural rate of unemployment is the rate at which the real wage chosen in the wage-setting relation equals the real wage implied by the price-setting relation.

Comparative Statics

• An increase in unemployment benefits raises the natural rate of unemployment.
• The wage-setting curve shifts right/up.
• An increase in the markup also increases the natural rate of unemployment.
• The price-setting curve shifts down.

Short-Term and Medium-Term

• In the short run, price levels may differ from expected price levels, leading to unemployment rates different from the natural rate, or output levels different from the natural level.
• Output tends to return to its natural level in the medium run due to the consistency of expectations.

This quiz delves into the intricacies of the labour market and its impact on prices, wages, and output. It explores concepts such as unemployment rates, types of labour markets, and wage determination through collective bargaining. Test your knowledge on how these elements shape employment dynamics.