The Labor Market: The Medium Run A 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 therefore prices

The Labor Market: The Medium Run A Medium Run Response to an Increase in Demand Higher prices lead workers to ask for higher wages…. Prices and wages (the labor market) adjust over the medium run and influence output

The Labor Market: The Medium Run A Tour of the Labor Market U.S. Population 1998 270.2 million Minus: Pop. under 16, -65.0 million Armed forces and Incarcerated Civilian Noninstitutional Pop. 205.2 million Civilian Labor Force 137.6 million Employed 131.4 million Unemployed 6.2 million Out of the Labor Force 67.6 million

The Labor Market: The Medium Run A Tour of the Labor Market The participation rate= What has caused the participation rate to increase over time?

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

The Labor Market: The Medium Run Labor Force Data, 1994 – 1999 (monthly flows) 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

A Tour of the Labor Market Differences Across Workers Monthly Separation Rates for Different Groups, 1968-1986 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

A Tour of the Labor Market Differences Across Workers 1998 Unemployment Rate U.S. 4.5% Males 16-19 16.2% African-Americans 8.9%

A Tour of the Labor Market Movements in Unemployment

A Tour of the Labor Market Small upward trend in the unemployment rate 1950s 4.5 1960s 4.7 1970s 6.2 1980s 7.3 1990s 5.9 The trend increase is dominated by large fluctuations in the unemployment rate 1992 7.7% (recession 1990-91) 1982 9.7% (recession 1981-82)

A Tour of the Labor Market Movements in Unemployment

A Tour of the Labor Market Movements in Unemployment

A Tour of the Labor Market Movements in Unemployment To Summarize: High Unemployment: Increases the probability of workers losing their jobs Reduces the probability of the unemployed finding a job Increases the duration of unemployment

A Tour of the Labor Market 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 that increase productivity and reduce the turnover rate.

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

A Tour of the Labor Market Wages and Unemployment: The expected price level, Pe & wages Workers base their wage request on the purchasing power of their wages or real wage W/P Employers base the wage they pay on the price of the product they sell or the real wage W/P Therefore, if Price (P) increases, wages (W) increase

A Tour of the Labor Market Wages and Unemployment: The unemployment rate, and wages Higher unemployment reduces bargaining power and wages Higher unemployment reduces the efficiency wage

A Tour of the Labor Market Wages and Unemployment: The other factors and wages Unemployment insurance: higher benefits leads to higher wages Structural Economic Change: wages increase when jobs created exceed jobs destroyed

A Tour of the Labor Market 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)

A Tour of the Labor Market Price Determination and the Production Function When perfect competition exists in the product market Price (P) = Marginal Cost Given: Marginal cost = W Then: P=W In non-competitive markets P=(i+µ)W µ= Markup of price over cost

A Tour of the Labor Market The Natural Rate of Unemployment The wage-setting relation Assume: Pe = P W=PF(u,z) and dividing by P The higher the unemployment rate (u), the lower the rate wage

A Tour of the Labor Market The Natural Rate of Unemployment The wage-setting relation: WS Unemployment Rate, u Real Wage, W/P Wage-setting relation (W/P varies inversely with u)

A Tour of the Labor Market The Natural Rate of Unemployment The Price-setting relation: Recall: Divide by W: Invert both sides:

A Tour of the Labor Market The Natural Rate of Unemployment The Price-setting relation: Recall: Observe: If markup (µ) increases Price (P) increases, given wages (W) Real wage falls Price setting a function of markup (µ)

A Tour of the Labor Market The Natural Rate of Unemployment The Price-setting relation: Price-setting relation (W/P is independent of u) Unemployment Rate, u Real Wage, W/P PS

A Tour of the Labor Market The Natural Rate of Unemployment Equilibrium Real Wages, Employment and Unemployment 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

A Tour of the Labor Market The Natural Rate of Unemployment / Structural Rate of Unemployment 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

A Tour of the Labor Market The Natural Rate of Unemployment 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 u reduces un

A Tour of the Labor Market The Natural Rate of Unemployment / Structural Rate of Unemployment From Unemployment to Output The Natural Level of Employment U = unemployment N = employment L = labor force u = unemployment rate Rearranging for N: N=L(1-u)

A Tour of the Labor Market The Natural Rate of Unemployment The Natural Rate of Unemployment / Structural Rate of Unemployment From Unemployment to Output The Natural Level of Employment N=L(1-u) un = natural rate of unemployment Nn = natural level of employment Nn = L(1-un)

A Tour of the Labor Market From Unemployment to Output The Natural Level of Output Assuming the Production Function: Y = N Yn = Nn = L(1-un)

A Tour of the Labor Market From Unemployment to Output Equilibrium Unemployment Rate: Natural level of output:

A Tour of the Labor Market Equilibrium Real Wages, Employment, and Unemployment At Yn the associated and the real wage chosen in wage setting equals the real wage implied by price setting.

A Tour of the Labor Market A Summary Assume: The expected price = actual price level Then: Wage setting implies the real wage is inversely related to unemployment The price setting real wage is constant Labor market equilibrium occurs when W/P wage setting = W/P price setting Labor market equilibrium determines the unemployment rate – the natural rate of unemployment

A Tour of the Labor Market Where We Go From Here Recall: Labor market equilibrium determines the natural level of unemployment which determines the natural level of output Observe: Monetary policy, fiscal policy, consumer confidence does not impact the natural level of unemployment and output

A Tour of the Labor Market 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