1. The Labor MarketEcon 302 Slide #1 The Labor Market: The Medium Run 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 A Medium Run Response to an Increase in Demand

2. The Labor MarketEcon 302 Slide #2 The Labor Market: The Medium Run Higher prices lead workers to ask for higher wages…. Prices and wages (the labor market) adjust over the medium run and influence output A Medium Run Response to an Increase in Demand

3. The Labor MarketEcon 302 Slide #3 The Labor Market: The Medium Run Employment 93.8 million Unemployment 6.5 million Out of labor force 57.3 million 1.0 0.8 1.6 1.5 1.3 1.6 Interpreting the Labor Force Data

4. The Labor MarketEcon 302 Slide #4 A Tour of the Labor Market The Large Flow of Workers Observations: 1. (Continued) Half of the flows from employment are quits Half of the flows from employment are layoffs 1.The size of the flows into and out of employment

5. The Labor MarketEcon 302 Slide #5 A Tour of the Labor Market The Large Flow of Workers Observations: Average monthly flow out of unemployment is 2.4 million 1.6 million to employment 0.8 million to out of the labor force Duration of unemployment is 3 months 2.The size of the flows into and out of unemployment in relation to the total number of unemployed

6. The Labor MarketEcon 302 Slide #6 A Tour of the Labor Market The Large Flow of Workers Observations: Each month: 350,000 new people enter 200,000 retire The aggregate flow indicates that many people move back and forth from participants to non-participants 3.The size of the flows into and out of the labor force

7. The Labor MarketEcon 302 Slide #7 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 35-44 Monthly Separation Rate (%) (Quits and Layoffs) 15.9 1.6 16.1 5.0

8. The Labor MarketEcon 302 Slide #8 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

9. The Labor MarketEcon 302 Slide #9 A Tour of the Labor Market Wage Determination Two Observations: 1.Workers’ wages exceed their reservation wage 2.Wages depend on labor-market conditions

10. The Labor MarketEcon 302 Slide #10 A Tour of the Labor Market Bargaining power depends on: 1.How easily can a worker be replaced. 2.How easily a worker can find another job. Wage Determination

11. The Labor MarketEcon 302 Slide #11 A Tour of the Labor Market Efficiency Wages: Wages above the reservation wage that increase productivity and reduce the turnover rate. Wage Determination

12. The Labor MarketEcon 302 Slide #12 A Tour of the Labor Market Wages and Unemployment Wage determination: W = Wage P e = Expected price level u = The unemployment rate z = Other variables that affect the wage setting

13. The Labor MarketEcon 302 Slide #13 A Tour of the Labor Market The expected price level, P e & wages Wages and Unemployment: 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

14. The Labor MarketEcon 302 Slide #14 A Tour of the Labor Market Wages and Unemployment: Higher unemployment reduces bargaining power and wages Higher unemployment reduces the efficiency wage The unemployment rate, and wages

15. The Labor MarketEcon 302 Slide #15 A Tour of the Labor Market Wages and Unemployment: Unemployment insurance: higher benefits leads to higher wages Structural Economic Change: wages increase when jobs created exceed jobs destroyed The other factors and wages

16. The Labor MarketEcon 302 Slide #16 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)

17. The Labor MarketEcon 302 Slide #17 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=(1+µ)W µ= Markup of price over cost

18. The Labor MarketEcon 302 Slide #18 A Tour of the Labor Market The Natural Rate of Unemployment The wage-setting relation Assume: P e = P W=PF(u,z) and dividing by P The higher the unemployment rate (u), the lower the rate wage

19. The Labor MarketEcon 302 Slide #19 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)

20. The Labor MarketEcon 302 Slide #20 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)

21. The Labor MarketEcon 302 Slide #21 A Tour of the Labor Market The Natural Rate of Unemployment The Price-setting relation: PS Price-setting relation (W/P is independent of u) Unemployment Rate, u Real Wage, W/P

22. The Labor MarketEcon 302 Slide #22 Unemployment Rate, u Real Wage, W/P u n – The natural rate of unemployment A Tour of the Labor Market The Natural Rate of Unemployment Equilibrium Real Wages, Employment and Unemployment Labor Market Equilibrium WS PS Wage-setting, F(u, Z) = Price-setting, A

23. The Labor MarketEcon 302 Slide #23 WS´ = F(u, Z´) A Tour of the Labor Market The Natural Rate of Unemployment Is the natural rate of unemployment “natural”? Scenario: Increase unemployment benefits (z increases) Is the natural rate of unemployment “natural”? Scenario: Increase unemployment benefits (z increases) Unemployment Rate, u Real Wage, W/P WS = F(u, Z) PS unun A B un´un´ The increase in Z increases u n

24. The Labor MarketEcon 302 Slide #24 A Tour of the Labor Market The Natural Rate of Unemployment Scenario: More stringent antitrust legislation (µ decreases) Real Wage, W/P WS = F(u, Z) PS unun un´un´ The decrease in u reduces u n PS´ Unemployment Rate, u

25. The Labor MarketEcon 302 Slide #25 A Tour of the Labor Market The Natural 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)

26. The Labor MarketEcon 302 Slide #26 A Tour of the Labor Market The Natural Rate of Unemployment From Unemployment to Output The Natural Level of Employment N=L(1-u) u n = natural rate of unemployment N n = natural level of employment N n = L(1-u n )

27. The Labor MarketEcon 302 Slide #27 A Tour of the Labor Market From Unemployment to Output The Natural Level of Output Y = N Y n = N n = L(1-u n ) Y = N Y n = N n = L(1-u n ) Assuming the Production Function:

28. The Labor MarketEcon 302 Slide #28 A Tour of the Labor Market From Unemployment to Output Equilibrium Unemployment Rate: Natural level of output:

29. The Labor MarketEcon 302 Slide #29 A Tour of the Labor Market Equilibrium Real Wages, Employment, and Unemployment At Y n the associated and the real wage chosen in wage setting equals the real wage implied by price setting.

30. The Labor MarketEcon 302 Slide #30 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 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

31. The Labor MarketEcon 302 Slide #31 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

32. The Labor MarketEcon 302 Slide #32 A Tour of the Labor Market Where We Go From Here Short-Run Price level may not equal the expected price Unemployment may equal natural unemployment level Output may equal natural output Price level may not equal the expected price Unemployment may equal natural unemployment level Output may equal natural output Medium- Term Price level tends to equal expected prices Unemployment tends to the natural rate Output moves toward the natural rate Price level tends to equal expected prices Unemployment tends to the natural rate Output moves toward the natural rate The Appropriate Time Frame