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The Labor Market : Wages … Prices … Wages. Medium Run Response to an Increase in Demand. Higher production requires an increase in employment Higher employment reduces unemployment Lower unemployment puts pressure on wages Higher wages increase production costs and prices

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the labor market wages prices wages
The Labor Market: Wages … Prices … Wages

Medium Run Response to an Increase in Demand

  • Higher production requires an increase in employment
  • Higher employment reduces unemployment
  • Lower unemployment puts pressure on wages
  • Higher wages increase production costs and prices
  • Higher prices lead workers to ask for higher wages….
  • Prices and wages (the labor market) adjust over the medium run and influence output
the labor market the medium run
The Labor Market: The Medium Run

A Tour of the Labor Market

U.S. Population 2003 291.0 million

Minus: Pop. under 16, -69.8 million

Armed forces and

Incarcerated

Civilian Noninstitutional Pop. 221.2 million

Civilian Labor Force 146.5 million

Employed 137.7 million

Unemployed 8.8 million

Out of the Labor Force 74.7 million

the labor market the medium run3

The participation rate=

The Labor Market: The Medium Run

A Tour of the Labor Market

The unemployment rate =

the labor market the medium run4

Employment

127 million

Job Change

3.5 million

1.5

1.5

Out of labor

force

66.7 million

Unemployment

7.0 million

1.7

1.8

1.1

1.3

The Labor Market: The Medium Run

Labor Force Data, 1994 – 1999 (monthly flows)

a tour of the labor market

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

A Tour of the Labor Market

Differences Across Workers

Monthly Separation Rates for Different Groups, 1968-1986

slide9

Movements in Unemployment

  • High Unemployment:
  • Increases the probability of workers losing their jobs
  • Reduces the probability of the unemployed finding a job
  • Increases the duration of unemployment
slide10

1.

Workers’ wages exceed theirreservation wage

2.

  • Wages depend on labor-market
  • conditions:
  • 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.

Wage Determination

slide11

Wage determination:

Wages and Unemployment

W = Wage

Pe = Expected price level

u = The unemployment rate

z = Other variables that affect the wage setting

slide12

Wage Setting Behavior:

The unemployment rate, and wages

The other factors and wages

The expected price level, Pe & wages

  • 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
  • Higher unemployment reduces bargaining power of labor and wages
  • Higher unemployment reduces the efficiency wage
  • Unemployment insurance: higher benefits  higher wages
  • Structural Economic Change: wages increase when jobs created exceed jobs destroyed
slide13

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)

In non-competitive markets:

P=(1+µ)W

µ= Markup of price over cost

  • If markup (µ) increases
  • Price (P) increases, given wages (W)
  • Real wage falls
slide14

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

The wage-setting relation

Pe = P in medium run, so

W =P F(u,z)

slide15

The Price-setting relation:

Price-setting relation

(W/P is independent of u)

Wage-setting relation

(W/P varies inversely with u)

PS

Real Wage, W/P

Real Wage, W/P

WS

Unemployment Rate, u

Unemployment Rate, u

The wage-setting relation:

slide16

Wage-setting, F(u, Z) =

Price-setting,

A

PS

Real Wage, W/P

WS

Unemployment Rate, u

Natural Rate of Unemployment …Structural Rate … Equilibrium Rate … NAIRU

Equilibrium Real Wages, Employment and Unemployment

Labor Market Equilibrium

un – The natural rate of unemployment

slide17

A

B

PS

WS´ = F(u, Z´)

WS = F(u, Z)

un´

un

The Natural Rate of Unemployment / Structural Rate of Unemployment

=The unemployment rate at which wage-setters accept the real wage they must accept, given markup μ.

Is the natural rate of unemployment “natural”?

Scenario: Increase unemployment benefits (z increases)

Real Wage, W/P

Unemployment Rate, u

The increase in Z increases un

slide18

PS

PS´

WS = F(u, Z)

un´

un

The Natural Rate of Unemployment

Scenario: More stringent antitrust legislation (µ decreases)

Real Wage, W/P

Unemployment Rate, u

The decrease in µ reduces un

slide19

From Unemployment to Output

U = unemployment

N = employment

L = labor force

u = unemployment rate

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

The Natural Level of Employment

N=L(1-u)

un = natural rate of unemployment

Nn = natural level of employment

Nn = L(1-un)

slide20

From Unemployment to Output

Equilibrium Unemployment Rate:

Natural level of output:

slide21

At Yn the associated

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

Equilibrium Real Wages, Employment, and Unemployment

slide22

Short-Run

  • 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

The Appropriate Time Frame