The Labor Market: Wages … Prices … Wages 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 prices Higher prices lead workers to ask for higher wages…. Prices and wages (the labor market) adjust over the medium run and influence output

Employment Status of the Population 2006 Jan-09 2009 (year) Total Population 301 306 307 Less: Under 16 Military 73 71 Institutionalized (Jail, Hospital) ____ _____ Non-institutionalized civilian population 228 235 236 Less: Not working or looking Retired Home - workers Full-time students 77 81 82 Idle rich Discouraged workers Civilian labor force 151 154 Employed 144 142 140 Unemployed 7 12 14 Participation rate = Laborforce/Non-inst. Population 66.4% 65.5% 65.4% Unemployment rate =Unemployed/Labor force 4.6% 7.6% 9.3% 381,000 734,000 Percent of labor force 0.25% 0.48%

The Labor Market: The Medium Run A Tour of the Labor Market The participation rate= The unemployment rate =

Labor Market Monthly Flows, 1996 – 2003 Labor Force Data, 1994 – 1999 (monthly flows) Separation rate = (2.8+1.8+2.8)/122 = 6% per month Employment 127 million Job Change 3.5 million Unemployment 7.0 million Out of labor force 66.7 million 1.1 1.3 1.7 1.5 1.8 Unemployed finding work = 1.4/6.2 = 23% /mo. Population leaving labor force/month = (2.8 + 1.4)/(122 +59.3) = 2.3 % Unemployed leaving unemployment each month = (1.4+1.4)/6.2 = 45% Avg duratation of unemployment = 1/.45 = 2.2 months

Monthly Separation Rate (%) Movements in Unemployment High Unemployment: Increases the probability of workers losing their jobs Reduces the probability of the unemployed finding a job Increases the duration of unemployment Differences Across Workers Category Male: Ages 16-19 35-44 Female: Ages 16-19 Monthly Separation Rate (%) (Quits and Layoffs) 15.9 1.6 16.1 5.0

Wage Determination 1. Workers’ wages exceed their reservation wage 2. Wages depend on labor-market conditions: How easily can a worker be replaced? How easily a worker can find another job? Efficiency Wages: Wages above the reservation wage Increase productivity Morale up Shirking down Monitoring costs down Reduce turnover rate. Reduce hiring costs.

Wages and Unemployment Wage determination: W = Wage Pe = Expected price level u = The unemployment rate z = Other variables that affect the wage setting

Wage Setting Behavior: The expected price level, Pe & wages Workers base their wage request on the purchasing power of their wages or real wage they expect, W/Pe Employers base the wage they pay on the expected price of the product they sell or the real wage, W/Pe  If Expected Price (Pe) increases, wages (W) increase The unemployment rate, and wages Higher unemployment reduces bargaining power of labor  wages decline with u, other things equal Higher unemployment reduces the efficiency wage The other factors and wages Unemployment insurance: higher benefits  higher wages Structural Economic Change: …wages increase when jobs created exceed jobs destroyed

Price Determination and the Production Function Assume labor is the only input, then Output Y = AN N = Employment A = Labor Productivity Assume A=1 Y = N If Y = N: then marginal cost = Wage (W) In non-competitive markets: P = (1+µ) W µ= Markup of price over cost If markup (µ) increases Price (P) increases, given wages (W) Real wage falls

The higher the unemployment rate (u), the lower the real wage, W/P The wage-setting relation Pe = P in medium run, so W = Pe F(u,z) = P F(u,z) The higher the unemployment rate (u), the lower the real wage, W/P

The Price-setting relation: The wage-setting relation: WS Wage-setting relation (W/P varies inversely with u) Price-setting relation (W/P is independent of u) Unemployment Rate, u Real Wage, W/P Unemployment Rate, u Real Wage, W/P PS

Labor Market Equilibrium Natural Rate of Unemployment …Structural Rate … Equilibrium Rate … NAIRU Labor Market Equilibrium Wage-setting, F(u, Z) = Price-setting, WS Unemployment Rate, u Real Wage, W/P A PS un – The natural rate of unemployment

The Natural Rate of Unemployment / Structural Rate of Unemployment = The unemployment rate at which wage-setters accept the real wage they must accept, given markup μ. Is the natural rate of unemployment “natural”? Scenario: Increase unemployment benefits (z increases) WS´ = F(u, Z´) WS = F(u, Z) un A B un´ PS Real Wage, W/P Unemployment Rate, u The increase in Z increases un

Scenario: More stringent antitrust legislation (µ decreases) WS = F(u, Z) PS´ un Real Wage, W/P PS un´ Unemployment Rate, u The decrease in µ reduces un

From Unemployment to Output U = unemployment N = employment L = labor force u = unemployment rate As output (Y) and employment (N) increase, the unemployment rate declines. As output (Y) increases, the real wage set by wage setters (W/P) increases. A “natural” or full employment level of output (Yn) corresponds to the “natural” rate of unemployment (un)

Equilibrium, Structural, or “Natural” Rate of Output WS Real Wage, W/P PS Yn Output, Y

Unemployment may not equal natural unemployment level The Appropriate Time Frame Short-Run Price level may not equal the expected price Unemployment may not equal natural unemployment level Output may not equal natural output Medium- Term Price level tends to equal expected prices Unemployment tends to the natural rate Output moves toward the natural rate