1. Unemployment

2. Large Variations in Labor per Person (www.ggdc.net)

3. Variation in Labor Force Participaton

4. Labor Demand given by marginal product of labor
= (L) = MPL(L) LD L

5. Labor Supply Wages affect willingness to work.
Substitution effect: Each hour of leisure time costs more in terms of goods when wages go up. This has the effect of increasing willingness to work.
Income/Wealth effect: Higher wages increase the size of your paycheck. Working hard may be less attractive when your wallet is full.
In theory, the effect of wages on labor supply could run either way. Most empirical findings find that labor supply is a weakly positive function of real wages.

6. Increasing Hours per Population in East Asia (http://www.ggdc.net)

7. Decreasing in Europe, Increasing in USA

8. Labor Demand given by marginal product of laborLS w* LD L L*

9. Labor Market
If labor market is competitive, then labor supply equals labor demand.
Equilibrium wages and labor are given at the point where two curves meet.
Increases in technology or capital increase average and marginal product of labor so they shift labor demand curve up.
Increase in Q or K, will increase or L in equilibrium

10. Labor Demand given by marginal product of laborLS
Q↑ or K↑
w** w* LD LD L
L** L*

11. Unemployment
Labor markets are characterized by sellers (workers) who would be willing to work at given wages but are not able to find work.
Unemployment rate is the ratio of unemployed to the labor force.
Unemployment varies across countries.

12. Differences in Unemployment Rates (http://www.oecd.org)

13. Rising Level of Unemployment in HK

14. Efficiency Wages
In standard model, we think of the cost of hiring workers as only the wage costs.
Efficiency wage theory assumes that costs are a function of turnover costs and costs of monitoring workers.
Real costs of hiring workers includes, ct, representing management costs.

15. Efficiency Wages
At the wage offered by firms, there is greater labor supply than demand.
Labor market competition does not bid down the wages to clear the market because firms know that if wages fall, their management costs will rise

16. Wage Bar LS
Unemployment
Efficiency Wage w* LD L L*

17. Labor Management Costs as a function of wages
Management costs are a function of the wage paid to workers.
If real wages are high, there will be relatively little turnover.
If real wages are high, workers will avoid shirking their jobs so as to keep their jobs.
Management costs relative to wage costs are highest when wages are low.

18. What determines wages
Firms don’t take market wages as given but select market wages to minimize labor costs including turnover costs.
Marginal cost of increasing wages is Lt.
Marginal benefit of increasing wages is marginal reduction of management costs
Wages minimize labor costs when marginal benefit equals marginal costs

19. Efficiency Wage 1 MC MB wE

20. Example Cost function Per Worker Marginal Benefit of Reducing Wages
Efficiency wages that minimize total costs.

21. Efficiency Wage
Wages offered by firms are set to minimize the per unit labor costs.
Principal determinant of the wage level are those things, E, which determine how sensitive management costs are to real wages.
Wages are not determined by intersection of labor demand.

22. What determines the demand for labor?
Once firms decide how much to pay their workforce to minimize labor costs, they decide their demand for workers based on the marginal product of labor.
Marginal cost of hiring workers includes both wages and management costs. Taking wages as given, marginal cost of hiring one more worker is
Marginal benefit of hiring one more worker, MPL. Firm maximizes profits by hiring workers until

23. At a given wage w, a firm chooses a labor demand which sets MPL = w +c(w)
c(wB) wB c
c(wA)
c(wA) wA
MPL LD LB LA

24. Labor Demand at Efficiency Wages
Labor demand is demand for labor at given wage once management costs are factored in.
Gap between labor demand and MPL curve is larger at lower wages because management costs are larger relative to wage costs.
Wage offer is decided at Labor solves
we + c(we) = MPL
Labor supply does not affect equilibrium labor market so there may be positive unemployment.

25. Labor demand determined by efficiency ways.we
MPL LD L*

26. Young workers most likely to be unemploymed because they are least skilled and management costs are high, so efficiency wages may not drop down to their level.

27. Unemployment is an increasing function of efficiency wage.LD LS
U(eW’)
we’
U(eW) we L*

28. Equilibrium Unemployment RateeW LD ur

29. What determines the sensitivity of management costs to wages.
Workers are most likely to increase their work effort when they are afraid of losing their job. This effect will be highest when
Unemployment is high.
Efficiency wages are a negative function of the unemployment rate.
Labor market regulations and unions allow firms to fire workers easily.
Social benefits are low relative to workers.

30. Equilibrium Unemployment RateeW LD
we* LS ur
ur*

31. Why does unemployment vary across countries.
In Europe, labor market regulations make it difficult for firms to fire workers. This increases management costs and allows workers to demand high wages to avoid shirking.
In Hong Kong, some argue that deflation has pushed up real value of social welfare payments which increases efficiency wage levels.

32. Increase in Firing Regulation or relative social welfare.eW LD
we**
LS’
we* LS ur
ur**
ur*

33. Unemployment may also be a function of economic conditions.

34. Unemployment is a negative function of labor demand curve.LD LS
U(eW) we
U(eW’) L*

35. Positive Productivity Shock
LD’ eW LD
we**
we* LS ur
ur**
ur*