MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT 1/12/2019 MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT 2nd edition Unemployment and the Labor Market PowerPoint by Beth Ingram University of Iowa Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Key Concepts Labor Force Marginal product of labor Real Wage Participation rate Employment rate Unemployment rate Marginal product of labor Real Wage Natural rate of unemployment

Defining the labor force Unemployed Labor Force Total Population Children under age 16 Students People working in the home (unpaid) Institutionalized Employed

Defining the labor force Participation Rate = Population Note that population here excludes those who are institutionalized Employed Employment Rate = Labor Force Unemployment Rate = 1 – Employment Rate

Demand for workers MPL Wage Amount of extra output produced by one more worker Assume All other factors of production fixed Decreasing returns Wage Nominal Wage: wage paid in current dollars Real Wage: wage corrected for price level

Demand for Workers MPL > Real Wage MPL < Real Wage Worker adds more to product than he/she costs – hire! MPL < Real Wage Worker costs more than he/she adds to output – DON’T hire!

Labor Demand Real Wage Dollars Marginal product of labor L0 Employment

Fall in real wage Dollars Employment Marginal product of labor W0

Fall in the real wage Increase in the quantity of labor demanded Produces labor demand curve

Labor Demand Real Wage W0 W1 Labor Demand Employment L1 L0 1/12/2019 Just to show how a decline in the wage is a shift along the labor demand curve. Labor Demand L0 L1 Employment

Labor Supply Can be affected by Decision to enter the labor force Choice of how much to work once employed What is the opportunity cost of working? Leisure time Education Home activities

Long run labor supply Determinants Data says is virtually vertical Demographic factors Labor market institutions Government policies Data says is virtually vertical

Short run labor supply Determined by level of real wage and opportunity costs Two effects Income effect Substitution effect

Income effect Assume a preference for non-work alternatives (home activities, leisure, etc.) Rising income allows us to enjoy more of those activities Hence, spend fewer hours working and more hours relaxing

Substitution effect What’s the cost of an hour of golf (assuming you aren’t a professional golfer)? Green fees, etc. The wage that you could have earned if you hadn’t been golfing Rising wage means golf ‘costs more’ Substitution effect says you should work more and golf less

On net, what do you do? Rising Wage Work more because of it’s more lucrative Rising Wage Work less because you’re richer

Labor Supply Labor supply Long Run Labor supply if Substitution Effect is bigger Real Wage Labor supply if Income Effect is bigger Employment

Labor Supply Upward sloping Labor supply if Substitution Effect is bigger Real Wage Employment

Short Run Equilibrium Labor supply Real Wage W0 Labor Demand L0 Employment

Long Run Equilibrium Labor supply Real Wage W0 Natural Level of Employment Labor Demand L0 Employment

Natural rate of unemployment Real Wage Price setting curve Wage setting curve Natural rate of unemployment Unemployment

Natural rate of unemployment Falling inflation and unemployment Real Wage Price setting curve Wage setting curve Natural rate of unemployment Unemployment

Natural rate of unemployment Rising inflation and unemployment Real Wage Price setting curve Wage setting curve Natural rate of unemployment Unemployment

Influences on the natural rate of unemployment Product market power Greater monopoly power in product markets means more unemployment Sensitivity of wage demand to unemployment Less responsiveness means more unemployment Monopoly power of unions Greater union strength means more unemployment

Labor Market Structure Union membership Unemployment benefits Proportion of long-term unemployed Regional- and skill-based mismatch Labor and consumption taxes

Labor Market Flows Some employed people lose their jobs Unemployment Pool The Employed (L) Some unemployed people get jobs

Labor Market Flows Probability of job loss is “p” Unemployment Pool (U) The Employed (L) Probability of finding a job is “s”

Equilibrium Flows p x L = s x U Total number = p x L Unemployment Pool (U) The Employed (L) Total number = s x U The level in the tub is constant if the flows balance. p x L = s x U

Equilibrium Flow p x L = s x U p x (LF – U) = s x U p x (LF/LF – U/LF) = s x U/LF p x (1 – u) = s x u

u* = p/(p – s) Natural rate of unemployment depends on Probability of finding a job (s) Higher s means less unemployment What affects s? Probability of losing a job (p) Higher p means more unemployment What affects p?

Employment Protection Legislation Measures to protect jobs Severance pay requirements Notice requirements Government approval for layoffs Effect Reduces probability of unemployment (p) Reduces probability of finding a job (s)

Figure 7.15a EPL and Unemployment

Figure 7.15b EPS and Employment Rate

Figure 7.15c EPL and Unemployment Inflows

Figure 7.15d EPS and Unemployment Outflows

Figure 7.15e EPS and Unemployment Duration

Figure 7.15f EPL and Duration of Employment

Labor Market Reform Pro-reform Anti-reform Encourage labor market turnover Decrease unemployment Anti-reform Increase income inequality Lower wages Other mechanisms exist to lower unemployment OECD: EPL in effect 2003

Inequality Rising income inequality Skilled wage premium Effect of global trade Effect of new technologies

Immigration Rising tide of immigration Empirical evidence Little effect on unemployment rates of domestic workers Declining wages for domestic workers 10% in foreign workers means 3 – 4% decline in wages for domestic workers

Effect of Immigration Labor supply Real Wage W0 W1 Labor Demand L1 L0 Employment

Summary Natural rate of unemployment Monopoly power model Flow model Factors that increase unemployment Factors that decrease unemployment Flow model EPL Labor market reform Inequality Immigration Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained therein.