the labor market: the medium run

Chapter 6: The Labor Market Slide #1Blanchard: Macroeconomics

The Labor Market: The Medium RunThe 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 DemandA 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

A Medium Run Response to an Increase in DemandA Medium Run Response to an Increase in Demand



A Tour of the Labor MarketA 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 millionOut of the Labor Force 67.6 million




)1998(%672.205

6.137

PopulationtionalNoninstitu

ForceLabor

The participation rate=

What has caused the participation rate to increase over time?



The unemployment rate =


)1998(%5.46.137

2.6

ForceLabor

Unemployed



Employment127 million

Job Change3.5 million

Unemployment7.0 million

Out of laborforce

66.7 million

1.1

1.3

1.7

1.51.5

1.8

Labor Force Data, 1994 – 1999 (monthly flows)Labor Force Data, 1994 – 1999 (monthly flows)



Differences Across WorkersDifferences 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)

15.91.6

16.15.0



Differences Across WorkersDifferences Across Workers

1998 Unemployment Rate

U.S. 4.5%Males 16-19 16.2%African-Americans 8.9%



Movements in UnemploymentMovements in Unemployment



Small upward trend in the unemployment rate

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




To Summarize: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



Wage DeterminationWage Determination

1. Workers’ wages exceed theirreservation wage

2. Wages depend on labor-marketconditions:

•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.



Wages and UnemploymentWages and Unemployment

Wage determination:Wage determination:

),(

),(

zuFPW e

W = WagePe = Expected price levelu = The unemployment ratez = Other variables that affect the wage setting



The expected price level, Pe & wagesThe expected price level, Pe & wages

Wages and Unemployment:Wages and Unemployment:

),(

),(

zuFPW e

•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




),(

),(

zuFPW e

• Higher unemployment reduces bargaining power and wages

• Higher unemployment reduces the efficiency wage

The unemployment rate, and wagesThe unemployment rate, and wagesu




),(

),(

zuFPW e

• Unemployment insurance: higher benefits leads to higher wages

• Structural Economic Change: wages increase when jobs created exceed jobs destroyed

The other factors and wagesThe other factors and wages)(z



Price Determination and the Production FunctionPrice Determination and the Production Function

Assume labor is the only input, thenAssume labor is the only input, then

Output (Y) = ANN = EmploymentA = Labor Productivity

Assume A=1Y = N

If Y=N: then marginal cost = Wage (W)



Price Determination and the Production FunctionPrice Determination and the Production Function

When perfect competition exists in the product marketWhen perfect competition exists in the product market

Price (P) = Marginal CostGiven: Marginal cost = WThen: P=W

In non-competitive markets P=(i+µ)W

µ= Markup of price over cost



The Natural Rate of UnemploymentThe Natural Rate of Unemployment

The wage-setting relationThe wage-setting relation

Assume: Pe = PW=PF(u,z) and dividing by P

),( zuFP

W

),(

The higher the unemployment rate (u), the lowerthe rate wage

P

W




The wage-setting relation:The wage-setting relation: ),( zuFP

W

),(

WS

Unemployment Rate, u

Rea

l W

age,

W/P

Wage-setting relation(W/P varies inversely with u)




The Price-setting relation:The Price-setting relation:

Recall: WP )1(

Divide by W: 1W

P

Invert both sides:

1

1

P

W





Recall: μP

W

1

1

Observe: • If markup (µ) increases

• Price (P) increases, given wages (W)

• Real wage falls

• Price setting a function of markup (µ)





1

1

P

W

PS

Price-setting relation(W/P is independent of u)


Rea

l W

age,

W/P

1

1



Rea

l W

age,

W/P

un – The natural rate of unemployment



Equilibrium Real Wages, Employment and UnemploymentEquilibrium Real Wages, Employment and Unemployment

Labor Market Equilibrium

WS

1

1PS

Wage-setting, F(u, Z) = Price-setting, 1

1

A


WS´ = F(u, Z´)


The Natural Rate of Unemployment / Structural Rate of UnemploymentThe Natural Rate of Unemployment / Structural 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)


Rea

l W

age,

W/P

WS = F(u, Z)

1

1PS

un

A B

un´

The increase in Z increases un




Scenario: More stringent antitrust legislation (µ decreases)Scenario: More stringent antitrust legislation (µ decreases)R

eal

Wag

e, W

/P

WS = F(u, Z)1

1PS

unun´

The decrease in u reduces un

´1

1

PS´





From Unemployment to OutputFrom Unemployment to Output

The Natural Level of EmploymentU = unemploymentN = employmentL = labor forceu = unemployment rate

L

N

L

NL

L

Uu

1

Rearranging for N: N=L(1-u)





The Natural Level of Employment

N=L(1-u)un = natural rate of unemploymentNn = natural level of employmentNn = L(1-un)





The Natural Level of Output

Y = NYn = Nn = L(1-un)Y = NYn = Nn = L(1-un)

Assuming the Production Function:

Assuming the Production Function:




Equilibrium Unemployment Rate:

1

1),( zuF n

Natural level of output: )1()( nn uLY

1

1),1( z

L

YF n

1

1),1( z

L

YF n



Equilibrium Real Wages, Employment, and UnemploymentEquilibrium Real Wages, Employment, and Unemployment

At Yn the associatedLY

un

n /

1

and the real wage chosen in wage settingequals the real wage implied by price setting.



A SummaryA 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



Where We Go From HereWhere We Go From Here

Recall: • Labor market equilibrium determines the natural level of unemployment which determines the natural level of output

• 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

• Monetary policy, fiscal policy, consumer confidence does not impact the natural level of unemployment and output



Short-Run • Price level may not equal the expected price

• Unemployment may not equal natural unemployment level

• Output may not equal natural output

• 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

• Price level tends to equal expected prices

•Unemployment tends to the natural rate

•Output moves toward the natural rate

The Appropriate Time FrameThe Appropriate Time Frame

the labor market: the medium run

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