The Labour Market PDF

The Labour Market DR A RPI TA B HA T TA CHA RJE E S HI V NA D AR I N S TI TU T IO N O F EM IN EN CE  ☛ We have focused on the short run by assuming a constant price level in an IS-LM model. ☛ We now turn to the medium run and explore how prices...

The Labour Market DR A RPI TA B HA T TA CHA RJE E S HI V NA D AR I N S TI TU T IO N O F EM IN EN CE  ☛ We have focused on the short run by assuming a constant price level in an IS-LM model. ☛ We now turn to the medium run and explore how prices and wages adjust over time, and how this in turn affects output. ☛ The labour market is the center of that sequence of events 09 /0 9/2 4  Unemployment Rate ➜ The unemployment rate is the ratio of the unemployed to the labour force. ➜ A given unemployment rate may reflect either: ▪ An active labor market: many separations and hires, i.e., many workers entering and exiting unemployment ▪ A sclerotic labor market: few separations and hires, and a stagnant unemployment pool ➜ Separations include quits and layoffs. ➜ The average duration of unemployment—the length of time people spend unemployed. 09 /0 9/2 4  ∘ Many who are classified as “out of the labor force” are in fact discouraged workers—not actively looking for a job but will take it if they find one. ∘ So rather than the unemployment rate, economists sometimes focus on the employment rate—the ratio of employment to the population 09 /0 9/2 4 When unemployment is high, workers are worse off in two ways: Employed workers face a higher probability of losing their job. Unemployed workers face a lower probability of finding a job; or they can expect to remain unemployed for a longer time. 09 /0 9/2 4  Unemployment Flows Figure 7.2 Average Monthly Flows between Employment, Unemployment, and Non-participation in the United States, 1996 to 2018 (Millions) 1. The flows of workers in and out of employment are large. 2. The flows in and out of unemployment are large relative to the number of unemployed. 3. There are also large flows in and out of the labour force, much of it directly to and from employment. Source: Calculated from the series constructed by Fleischman and Fallick, www.federalreserve.gov/econresdata/researchdata/feds200434.xls. 09 /0 9/2 4  Wage Determination ∘ Sometimes wages are set by collective bargaining—a bargaining between unions and firms. ∘ Slightly more than 10% of U.S. workers’ wages are set by collective bargaining. ∘ The higher the skills needed to do the job, the more likely there is to be bargaining between employers and individual employees. ∘ Collective bargaining plays an important role in Japan and most European countries. 09 /0 9/2 4  Wage Determination ∘ Workers are typically paid a wage exceeding their reservation wage—the wage that would make them indifferent between working or being unemployed. ∘ Wages typically depends on labour-market conditions: the lower the unemployment rate, the higher the wages. ∘ Workers’ bargaining power depends on: ☛How costly for the firm to find other workers ☛How hard for workers to find another job if they were to leave the firm 09 /0 9/2 4  Wage Determination ∘ Efficiency wage theories link the productivity or the efficiency of workers to the wage they are paid. ∘ Firms may want to pay a wage above the reservation wage to decrease workers’ turnover and increase productivity. ∘ Firms that see employee morale and commitment as essential to the quality of workers’ work will pay more than those whose activities are routine. ∘ When unemployment is low, firms that want to avoid an increase in quits and will increase wages to induce workers to stay with the firms. 09 /0 9/2 4  Wage Determination The aggregate nominal wage 𝑊 depends on: 1. the expected price level, 𝑃𝑒 2. the unemployment rate, 𝑢 3. a catch-all variable, 𝑧 𝑊 = 𝑃 𝑒 𝐹 𝑢, 𝑧 (7.1) (−, +) 09 /0 9/2 4  𝑊 ☛ Both workers and firms care about real wages, ( ), 𝑃 not nominal wages. ☛ The nominal wage depends on the expected price level (rather than the actual price level) －because when nominal wages are set, the relevant price levels are not yet known. 09 /0 9/2 4  ∘ An increase in the unemployment rate decreases wages. ⁃ Higher unemployment either weakens workers’ bargaining power or allows firms to pay lower wages and still keep workers willing to work. ∘ 𝑧 stands for all the factors that affect wages given the expected price level and the unemployment rate, for example: ⁃ unemployment insurance as the payment of unemployment benefits to workers who lose their jobs ⁃ employment protection makes it more expensive for firms to lay off workers 09 /0 9/2 4  Price Determination The prices set by firms depends on their costs, which in turn depends on the nature of the production function: Y = AN where Y is output, N is employment and A is labour productivity (output per worker). The production function is the relation between the inputs used in production and the quantity of output produced, and on the prices of these inputs. 09 /0 9/2 4  Price Determination Assume that 𝐴 is constant and 𝐴 = 1, then: 𝑌 = 𝑁 (7.2) → which implies that the cost of producing one more unit of output is the cost of employing one more worker at 𝑊. → The marginal cost of production is equal to 𝑊. Now assume firms set their price according to a markup 𝑚 over the cost: 𝑃= 1+𝑚 𝑊 (7.3) 09 /0 9/2 4 Assume that 𝑊 depends on the actual price level (𝑃) rather than the expected price level (𝑃𝑒), then equation (7.1) becomes: 𝑊 = 𝐹 𝑢, 𝑧 (7.4) 𝑃 (−, +) ➜ Higher the unemployment rate, lower the real wage chosen by wage setters. ➜ Wage-setting relation – between real wage and unemployment rate 09 /0 9/2 4 Divide both sides of the price-determination equation (7.3) by nominal wage: 𝑃 =1+𝑚 (7.5) 𝑊 Inverting both sides gives the implied real wage, or the price-setting relation: 𝑊 1 = (7.6) 𝑃 1+𝑚 → Price-setting decisions determine the real wage paid by firms. 09 /0 9/2 4  𝑊 The equilibrium unemployment rate 𝑢𝑛 can be derived by eliminating 𝑃 between equations (7.4) and (7.6): 1 𝐹 𝑢𝑛 , 𝑧 = (7.7) 1+𝑚 → 𝑢𝑛 depends on 𝑧 and 𝑚. 𝒖𝒏 is also called the natural rate of unemployment or the structural rate of unemployment. 09 /0 9/2 4  The Natural Rate of Unemployment The natural rate of unemployment is the unemployment rate such that the real wage chosen in wage setting is equal to the real wage implied by price setting. 09 /0 9/2 4  Comparative Statics An increase in unemployment benefits leads to an increase in the natural rate of unemployment. By equation (7.4), wage-setting curve shifts right/up (higher real wage for given unemployment rate): 𝑊 𝑃 = 𝐹 𝑢, 𝑧 7.4 (−, +) 09 /0 9/2 4  Comparative Statics An increase in the markup leads to an increase in the natural rate of unemployment. By equation (7.6), price-setting curve down (lower real wage for given unemployment rate): 𝑊 1 = (7.6) 𝑃 1+𝑚 09 /0 9/2 4  We have assumed that the price level is equal to the expected price level. In the short run, the price level may well turn out to be different from what is expected when nominal wages are set, so that unemployment is not necessarily equal to the natural rate or output equal to its natural level. Because expectations are unlikely to be systematically wrong, in the medium run, output tends to return to its natural level. 09 /0 9/2 4