©2012 The McGraw-Hill Companies, All Rights Reserved 1 Chapter 16: Wages and Unemployment

©2012 The McGraw-Hill Companies, All Rights Reserved 2 Learning Objectives 1.Use a supply-and-demand model to understand the labor market 2.Explain the relationship between the supply of and the demand for labor and real wages and employment 3.Define and calculate the unemployment rate and the participation rate 4.Differentiate among the three types of unemployment and the costs associated with each

©2012 The McGraw-Hill Companies, All Rights Reserved 3 Supply and Demand in The Labor Market Supply and demand analysis can be used to find the price of labor (real wages) and the quantity (employment)  Analysis will consider the number of workers employed, not work-hours per year 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

©2012 The McGraw-Hill Companies, All Rights Reserved 4 Wages and Demand for Labor The demand for labor depends upon:  The productivity of workers  Greater productivity increases employment  The price of the worker’s output  Higher real prices increases employment Diminishing returns to labor  Assumes non-labor inputs are held constant  Adding one worker increases output but by less than the previous worker added Value of Marginal Product (VMP) is extra revenue that an added worker generates

©2012 The McGraw-Hill Companies, All Rights Reserved 5 Manama Computer Company (MCC) Number of Workers Computers per Year Value of Marginal Product $75,000 69,000 63,000 57,000 51,000 45,000 39,000 33,000 Marginal Product  MCC can sell all its computers for $3,000 each

©2012 The McGraw-Hill Companies, All Rights Reserved 6 Demand Curve for Labor Hire an extra worker if and only if the VMP exceeds the wage paid If wage is $60,000, MCC will hire 3 workers  At $50,000, MCC hires 5 workers The lower the wage, the more workers employed Employment Wage ($000s) Labor Demand

©2012 The McGraw-Hill Companies, All Rights Reserved 7 Shifts in the Demand for Labor Demand shifts when the value of the marginal product of a worker changes Two factors determine the demand (VMP) for labor  The price of the company’s output  An increase in market demand  The productivity of the workers  Greater quantity of non-labor inputs  Organizational change  Training and education

©2012 The McGraw-Hill Companies, All Rights Reserved 8 Price of Output Increases Number of Workers Computers per Year Value of Marginal Product $125, , ,000 95,000 85,000 75,000 65,000 55,000 Marginal Product  MCC can now sell all its computers for $5,000 each

©2012 The McGraw-Hill Companies, All Rights Reserved 9 Price of Output Increases When price was $3,000 MCC hired 3 workers When price is $5,000 MCC will hire 7 workers  Demand for labor increased from 3 to 7 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)

©2012 The McGraw-Hill Companies, All Rights Reserved 10 Higher Productivity Number of Workers Computers per Year Value of Marginal Product $112, ,500 94,500 85,500 76,500 67,500 58,500 49,500 Marginal Product  Each technician builds 50% more machines

©2012 The McGraw-Hill Companies, All Rights Reserved 11 Higher Productivity  Increases in productivity increase VMP  MCC hires 6 instead of 3  Demand curve shifts right  Employers hire more workers at any given wage  Increases in productivity increase VMP  MCC hires 6 instead of 3  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)

©2012 The McGraw-Hill Companies, All Rights Reserved 12 The Supply of Labor Reservation wage is the lowest wage a worker would accept for a given job  Will you go to the beach or clean your parents’ basement?  Opportunity cost of working is your leisure activity  Work compensates you for lost leisure  If working conditions are unpleasant or dangerous, a premium for that would be included in the wage  Cost – Benefit Principle at work

©2012 The McGraw-Hill Companies, All Rights Reserved 13 Aggregate Labor Supply People work for many reasons:  Personal satisfaction  Opportunity to develop skills and talents  Chance to socialize with co-workers Still, for most people, income is one of the principal benefits of working  The higher the real wage, the more willing they are to sacrifice other possible uses of their time The fact that people are more willing to work when the wage they are offered is higher is captured in the upward slope of the supply curve of labor

©2012 The McGraw-Hill Companies, All Rights Reserved 14 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

©2012 The McGraw-Hill Companies, All Rights Reserved 15 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 net immigration  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

©2012 The McGraw-Hill Companies, All Rights Reserved 16 Explaining The Trends in Real Wages and Employment We have discussed both the demand for and supply of labor separately We are ready to apply supply and demand analysis to real-world labor markets To do so we need to examine supply and demand of labor in the same graph

©2012 The McGraw-Hill Companies, All Rights Reserved 17 Trend 1: Increasing Real Wages Industrialized countries have had sustained growth in productivity over many decades  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'

©2012 The McGraw-Hill Companies, All Rights Reserved 18 Trend 2: Increased Wage Inequality 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 Globalization also means that some goods produced domestically are no longer competitive  Some domestic sectors shrink  The effects of globalization on the labor market are mixed

©2012 The McGraw-Hill Companies, All Rights Reserved 19 Trend 2: Increased Wage Inequality 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

©2012 The McGraw-Hill Companies, All Rights Reserved 20 Trend 2: Increased Wage Inequality Domestic market starts in equilibrium at wage W  N T workers are in the textile industry  N S workers are in the software industry Globalization opens borders and country begins importing textiles and exporting software  Demand for domestic textiles decreases as some textiles are bought overseas  This decreases the wage in the textile industry to W' T and employment decreases to N' T

©2012 The McGraw-Hill Companies, All Rights Reserved 21 Trend 2: Increased Wage Inequality Domestic market starts in equilibrium at wage W  N T workers are in the textile industry  N S workers are in the software industry Globalization opens borders and country begins exporting textiles and importing software  Exports cause an increase in demand, employment, and wages  The result is a wage differential (W' S – W' T ) where none existed before

©2012 The McGraw-Hill Companies, All Rights Reserved 22 Trend 2: Increased Wage Inequality When wages in importing industries fall and wages in exporting industries rise, wage inequality increases  Low-skill industries face the toughest international competition  Political resistance to free trade grows Worker mobility is the movement of workers between jobs, firms, and industries  Market incentives move workers out of textiles and into software  Transition aid by government can assist workers to make the change

©2012 The McGraw-Hill Companies, All Rights Reserved 23 Trend 2: Increased Wage Inequality Technological change can be a source of increasing wage inequality  Occurs if technical change favors higher-skilled or better-educated workers Some innovation renders old skills less valuable  Addition and the calculator and computer 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

©2012 The McGraw-Hill Companies, All Rights Reserved 24 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

©2012 The McGraw-Hill Companies, All Rights Reserved 25 Unemployment and the Unemployment Rate In most countries, a government agency is responsible for conducting a survey of households and the labor force and defining and measuring unemployment Employed: works full-time or part-time Unemployed: unemployed but is actively seeking employment Out of the labor force: unemployed and is not actively seeking employment  Full-time students, unpaid homemakers, retirees, and people unable to work because of disabilities  Discouraged job seekers who have given up searching for employment

©2012 The McGraw-Hill Companies, All Rights Reserved 26 Unemployment and the Unemployment Rate Measuring Unemployment Labor force = employed + unemployed Unemployment rate = unemployed / labor force Participation rate = labor force / population 16 + Population Age 16 + Employed Unemployed Out of the Labor Force

©2012 The McGraw-Hill Companies, All Rights Reserved 27 Unemployment and Labor Force Participation Rates

©2012 The McGraw-Hill Companies, All Rights Reserved 28 Unemployment in Egypt, 1970 – 2008

©2012 The McGraw-Hill Companies, All Rights Reserved 29 Unemployment in Morocco, 1999– 2008

©2012 The McGraw-Hill Companies, All Rights Reserved 30 Unemployment in Tunisia, 1999– 2008

©2012 The McGraw-Hill Companies, All Rights Reserved 31 Costs of Unemployment Unemployment imposes:  Economic costs  Lost wages and production  Decreased taxes and increased transfers  Psychological costs  Individual self-esteem  Family stress of decreased income and increased uncertainty  Social costs  Potential increases in crimes and social problems Social resources spent to address these  Anger, frustration, and despair may result in social rebellion Uprisings in Tunisia, Egypt, Algeria, Bahrain, Libya, Syria, and Yemen

©2012 The McGraw-Hill Companies, All Rights Reserved 32 “True” Unemployment Discouraged workers would like to have a job but they have not looked for work (during the survey period)  Counted as out of the labor force  Willing and ready to work  Could be counted as unemployed but they are not Involuntary part-time workers are people who like to work full-time but cannot find a full- time job  Counted as employed

©2012 The McGraw-Hill Companies, All Rights Reserved 33 Types of Unemployment Short-term unemployment that is associated with the process of matching workers with jobs is called frictional unemployment Because the labor market is heterogeneous and dynamic, the process of matching jobs with workers often takes time The costs of frictional unemployment are low and may even be negative; that is, frictional unemployment may be economically beneficial (better match)

©2012 The McGraw-Hill Companies, All Rights Reserved 34 Types of Unemployment Structural unemployment is long-term, chronic unemployment in a well-functioning economy due to  Lack of skills, language barriers, or discrimination  Structural shifts in production create a long-term mismatch between workers and market needs  Barriers to employment such as  Minimum wages ■ Unions  Unemployment Insurance  Cause high economic, psychological, and social costs

©2012 The McGraw-Hill Companies, All Rights Reserved 35 Structural Barriers to Employment: Minimum Wage 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

©2012 The McGraw-Hill Companies, All Rights Reserved 36 Structural Barriers to Employment: Labor Union  Labor union benefits  Reduced worker exploitation  Support progressive labor legislation  Increase productivity  Promote democracy in the workplace  Labor union costs  Introduces inefficiency into competitive markets  May keep companies from competing globally  Increase labor supply in non-union sector Decreases wages for non-union workers

©2012 The McGraw-Hill Companies, All Rights Reserved 37 Structural Barriers to Employment: Unemployment Insurance 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

©2012 The McGraw-Hill Companies, All Rights Reserved 38 Types of Unemployment Cyclical unemployment is the increase in unemployment during economic slow- downs (recessions)  Usually short duration  Significant economic cost since it is associated with decline in real GDP

©2012 The McGraw-Hill Companies, All Rights Reserved 39 Other Government Regulations Health and safety regulations can reduce the demand for labor by  Increasing employer costs  Reducing productivity The reduction in demand will increase unemployment and lower wages

©2012 The McGraw-Hill Companies, All Rights Reserved 40 Unemployment in Western Europe,

©2012 The McGraw-Hill Companies, All Rights Reserved 41 Why Are Unemployment Rates High in Europe? Structural rigidities explain persistently high rates  Highly regulated labor markets  High minimum wages  Generous unemployment benefits  Powerful labor unions This lack of flexibility in labor markets—which some observers refer to as Eurosclerosis— causes higher frictional and structural unemployment