1. 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.

2. 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

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

4. 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

5. 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

6. 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!

7. Labor Demand
Real Wage
Dollars
Marginal product of labor L0
Employment

8. Fall in real wage Dollars Employment Marginal product of labor W0

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

10. 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

11. 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

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

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

14. 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

15. 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

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

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

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

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

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

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

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

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

24. 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

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

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

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

28. 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

29. 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

30. 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?

31. 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)

32. Figure 7.15a EPL and Unemployment

33. Figure 7.15b EPS and Employment Rate

34. Figure 7.15c EPL and Unemployment Inflows

35. Figure 7.15d EPS and Unemployment Outflows

36. Figure 7.15e EPS and Unemployment Duration

37. Figure 7.15f EPL and Duration of Employment

38. 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

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

40. 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

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

42. 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
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