McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved Chapter 6 Wages and Unemployment

6-2 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 18- All Learning Objectives 1.Discuss the five important trends that characterized the labor markets since Use a supply-and-demand model to understand the labor market 3.Explain how changes in the supply of and demand for labor explain trends in real wages and employment since Define and calculate the unemployment rate and the participation rate

6-3 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Trends In Real Wages 1.Over the 20 th century, all industrial countries have enjoyed substantial growth in real wages.  US real earnings are about twice real earnings in 1960, nearly five times real earnings in Since the early 1970s, the rate of real wage growth has slowed.  : real yearly earnings rose by 2.5% per year  : real yearly earnings fell by 1.1% per year  : real yearly earnings rose by 1% per year

6-4 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Trends In Real Wages 3. In the United States, wage inequality has increased dramatically in recent decades.  Between 1960 and 2007  Real wages of the least-skilled, least-educated workers decreased 25 to 30%  Best-educated, highest-skilled workers enjoyed continued gain in real wages  Income with an advanced degree beyond college is  Three times the income of a high school graduate  Four times the income of a worker who did not graduate from high school

6-5 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Trends In Employment and Unemployment 4. Increasing Employment in US  Between 1980 and 2007 employment increased 46%  At the same time over-16 population increased only 38% 5. High rates of unemployment in Europe  Between 1990 and 2007, France had 10% unemployment, while US had 5.5% in the same period  Europe had low rates of job creation With increasing wage inequality in the US and high unemployment in Europe, a share of the industrialized workforce has not shared in growing prosperity

6-6 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO The Labor Market  Supply and demand analysis can be used to find the price of labor (real wages) and the quantity (employment)  Labor market is an input market  Firms buy labor to produce goods and services  Macroeconomics look at aggregate levels of employment and real wages  Microeconomics looks at wage determination for a category of workers

6-7 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Banana Computers (BCC) Number of Workers Computers per Year  BCC can sell all its computers for $3,000 each Value of Marginal Product $75,000 69,000 63,000 57,000 51,000 45,000 39,000 33,000 Marginal Product

6-8 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Wages and Demand for Labor  Diminishing returns to labor  Principle of Increasing Opportunity Cost  Value of Marginal Product (VMP) is extra revenue that an added worker generates. Hire an extra worker if and only if the VMP exceeds the wage paid

6-9 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Demand Curve for Labor  If wage is $60,000, BCC will hire 3 workers  At $50,000, BCC hires 5 workers  the lower the wage, the more workers employed Employment Wage ($000s) Labor Demand

6-10 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Shifting Demand for Labor  Demand shifts when the value of the marginal product of a worker changes  Two factors determine the VMP, thus the demand for labor  The price of the company’s output  The productivity of the workers

6-11 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Price of Output Increases  If the price of computers increases, demand for labor shifts to the right  There is a separate demand for labor curve for each possible output price  An increase in the price of workers' output increases the demand for labor Employment Real Wage ($000s) Labor Demand (P = $3,000) Labor Demand (P = $5,000)

6-12 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Higher Productivity  Increases in productivity increase VMP  Demand curve shifts right  Employers hire more workers at any given wage  Increases in productivity increase VMP  Demand curve shifts right  Employers hire more workers at any given wage Employment Real Wage Labor Demand (before productivity increase) Labor Demand (after productivity increase)

6-13 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO The Supply of Labor  Reservation wage is the lowest wage a worker would accept for a given job  Opportunity cost of working is your leisure activity  Work compensates you for lost leisure  Cost – Benefit Principle at work

6-14 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO The Supply of Labor Employment Real Wage Labor Supply The labor supply curve slopes up because the higher the real wage, the more people are willing to work

6-15 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Shifts in Labor Supply  A shift in labor supply is caused by any change in the number of workers willing to work at each wage  Increase in the working-age population  Baby Boom  Higher immigration rate  Increasing age at retirement  Increase in the share of working-age population willing to work  Women's participation in the labor force has increased in the last 50 years

6-16 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Trend 1: Increasing Real Wages  Industrialized countries have had sustained growth in productivity in the 20 th century  Increases demand for labor  Both real wages and employment increased  Productivity increases were due to  Technological progress  Increases in capital Employment Real Wage S D W N W' N' D'

6-17 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Trend 2 and 4: Slower Real Wage Growth and Rapid Growth in Employment since 1970  Slower productivity growth, thus slower growth in demand for labor  Increase in supply of labor  Increased participation by women  Baby Boom  High rates of immigration

6-18 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Trend 3: Increased Wage Inequality in US  Globalization results in an expansion of many markets to worldwide supply  Increasing ease of goods and services crossing national borders  Benefit of globalization is increased specialization and efficiency  Principle of Comparative Advantage

6-19 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Trend 3: Increased Wage Inequality in US Employment Real Wage Employment STST DTDT W NTNT S DSDS NSNS D' T W’ T N' T D' S W' S N' S Software Textiles

6-20 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO  When wages in importing industries fall and wages in exporting industries rise, wage inequality increases  Labor market adjust on its own to ease this effect  Worker mobility is the movement of workers between jobs, firms, and industries  Market incentives move workers out of textiles and into software  Reduce labor supply in textiles and increase it in software Trend 3: Increased Wage Inequality in US

6-21 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Trend 3: Increased Wage Inequality in US  Technological change can be a source of increasing wage inequality  Occurs if technical change favors higher-skilled or better-educated workers  Skill-biased technological change affects the marginal products of higher skilled workers differently from those of lower-skilled workers  Recent changes favor higher skilled workers  Automobile production lines increasingly use robots

6-22 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Skill-Biased Technological Change Employment Real Wage Unskilled Workers W' S N' U SUSU DUDU NUNU WSWS Employment Skilled Workers D' S S NSNS WSWS DSDS D' U N' S W' S

6-23 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Unemployment  Bureau of Labor Statistics (BLS) estimates employment and unemployment monthly  Labor force = employed + unemployed  Unemployment rate = unemployed / labor force  Participation rate = labor force / population 16 +

6-24 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO US Employment Data, Jan 2008 Employed146.2 million Unemployed7.6 million Labor Force153.8 million Not in the Labor Force78.8 million Working-Age Population232.6 million Unemployment Rate4.9% Participation rate66.1%

6-25 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO US Unemployment Rate,

6-26 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Barriers to Full Employment Employment Real Wage D S N W A W min NANA B NBNB Minimum Wage Laws  Setting a minimum wage (W min ) above equilibrium (W) creates (N B – N A ) unemployment  Workers who find a minimum-wage job get a higher wage  Others are unemployed

6-27 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 18- All Barriers to Full Employment  Unemployment insurance are government transfers to unemployed workers  Helps to reduce the costs of unemployment  May give the unemployed an incentive to search longer and less intensely  To work efficiently, unemployment benefits should be  For a limited time  Less than the income received when working

6-28 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO Unemployment in Western Europe,

6-29 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 18- All Trend 5: High Unemployment in Europe  The explanation still lies in globalization and skill- biased technological change  In US, falling demand in unskilled labor has depressed the wages of the less skilled, increasing wage inequality  In Western Europe, high minimum wage, generous unemployment insurance create a wage floor for unskilled labor.

6-30 © The McGraw-Hill Companies, Inc., 2009 McGraw-Hill/Irwin LO 18 - All Wages and Unemployment Five Trends Labor Market Demand for Labor Supply of Labor UnemploymentUnemployment