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FIN 30220: Macroeconomic Analysis. Labor Markets. Of the 317 million people that make up the US population, approximately 246 million are considered by the Bureau of Labor Statistics to be “eligible” to work. Eligible Civilian Population 246 Million.

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Of the 317 million people that make up the US population, approximately 246 million are considered by the Bureau of Labor Statistics to be “eligible” to work.

Eligible Civilian Population 246 Million

US Population 317Million

  • Under 16

  • On Active Military Duty

  • Inmates in Penal or Mental Institutions

Non-Eligible Population 71 Million


The US labor market is a very dynamic market. The approximately 246 million are considered by the Bureau of Labor Statistics to be “eligible” to work. 246 million Americans currently counted as part of the US eligible population are in a constant state of motion between three possible states

10M

Unemployment Rate (UR)

=

= 6.4%

155M

Employed 145 Million

155M

Participation Rate (PR)

=

= 63%

246M

145M

Employment Rate (ER)

=

= 59%

Not In Labor Force 91 Million

246M

Unemployed 10 Million

ER

UR =

1 -

PR

Source: Household Survey


The Natural Rate, or NAIRU (Non Accelerating Inflation Rate of Unemployment) refers to what’s “normal” in the labor market.

Cyclical Unemployment

“Natural Rate”

If unemployment is at the “natural rate”, then the inflation rate should be stable.


Note that the “Natural Rate” of unemployment is not zero! A healthy labor market should have some turnover as workers look for better jobs.

5%

Frictional Unemployment: Workers in the process of finding a job

1.5%

Structural Unemployment: Workers whose skills are no longer needed due to industry evolution. These people generally require retraining

0%


A better measure of the labor market is simply the total number of people working

Total

Change From Previous Month

Recession

Recession

Recession


What’s a “good” employment number number of people working ?

Labor Market

US Population 300 Million

Every month, people retire, go back to school, etc.

Our population growth rate averages around 1% per year

250,000 per month

100,000 per month

To maintain a constant unemployment rate, we need to create approximately 150,000 jobs per month!!


The employment figures generally coincide with the unemployment rate, but not always

Unemployment Rate

Change in Employment

Unemployment Rate


Consider two economies. Both have a labor force equal to 100. In economy A, 10 people lose their jobs every month (but find a job the following month). In Economy B, 10 people get laid off every 3 months, but take three months to find work.

A

10

10

10

10

10

10

January

February

March

April

May

June

July

B

10

10

At any point in time, both economies have identical unemployment rates of 10%

Duration measures the average length of an unemployment spell. Economy A has a duration of 1 month. Economy B has a duration of 3 months.


Suppose that we have the following data. 100. In economy A, 10 people lose their jobs every month (but find a job the following month). In Economy B, 10 people get laid off every 3 months, but take three months to find work.

Labor Force = 200M

January

February

March

April

May

June

3 Million

24 Weeks

3 Million

3.5 Million

12 Weeks

3.5 Million

12 Weeks

7 Million

2.5 Million

8 Weeks

2.5 Million

8 Weeks

2.5 Million

8 Weeks

+

7.5 Million

17.5 Million

9M

Unemployment Rate =

= 4.5%

200M

3M

7M

7.5M

+

+

Average Duration =

24

12

8

= 12.3 weeks

17.5M

17.5M

17.5M


Length of unemployment spells in the US 100. In economy A, 10 people lose their jobs every month (but find a job the following month). In Economy B, 10 people get laid off every 3 months, but take three months to find work.


However, average and median duration has been rising! 100. In economy A, 10 people lose their jobs every month (but find a job the following month). In Economy B, 10 people get laid off every 3 months, but take three months to find work.

Mean = 39 weeks

Median = 22 weeks


Production Functions measure the relationship between inputs and output

Labor

Output

Capital (Fixed in Short Run)

Productivity (Exogenous)

Typically the production function used is Cobb-Douglas

Capital’s Share of Income

Labor’s Share of Income


Production in the short run – capital is fixed and output

The Marginal Product of Labor (MPL) measures the change in production associated with a small change in employment

MPL=2

2

10

MPL=10

As labor increases (given a fixed capital stock), labor productivity declines!!

1

1


Production in the short run – capital is fixed and output

or

MPL=4

We also assume that the marginal product of labor is positively related to increases in either productivity and capital

MPL=2

MPL=14

MPL=10


We assume that firms are perfectly competitive. They choose labor hours to maximize profits

Wage Rate

Price of Capital

Labor Costs

Capital Costs (Fixed in Short Run)

Price of Output

Total Output


The best choice for labor can be found by taking looking at changes in both revenues and costs at the margin.

A little rearranging gives us the following condition

Real Wage

Qualitatively, this tells us we would expect to see a strong positive correlation between productivity and wages


Example: changes in both revenues and costs at the margin.

For the production function given above, at a real wage of 8, 4 hours of labor are hired


Labor demand records the hiring decision (# of hours) chosen by the firm at every real wage

Real Wage

Hours of Labor


Altering the real wage (holding production values fixed) allows us to trace out the labor demand curve

Real Wage

Hours of Labor


Altering the production values (holding the real wage fixed) allows us to shift the labor demand curve

Real Wage

Hours of Labor


Households have utility functions that describe the relationship between choices and happiness

Labor Hours

Utility

Time Endowment

Consumption

  • We only have a couple requirements for utility functions

    • Utility is increasing in consumption (i.e. we like to buy things!)

    • Utility is decreasing in labor (we don’t like to work)

    • Utility exhibits diminishing marginal utility (the more we have of anything, the less it is worth to us at the margin)


Indifference curves show various combinations of consumption and leisure that provide the same level of utility

More is always better!

C

A

B


The marginal rate of substitution (MRS) and leisure that provide the same level of utility measures the amount of consumption you are willing to give up in order to acquire a little more leisure

How much consumption do you require to give up one hour of leisure (i.e. work an extra hour)?


Given the assumption of diminishing marginal utility, MRS varies predictably as consumption/leisure changes

If you have a lot of consumption relative to leisure, then leisure is much more valuable than consumption - MRS is high!

If you have a lot of leisure relative to consumption, then leisure is much less valuable than consumption - MRS is low!

MRS = 12

MRS = 2


Households take wages and prices as given. varies predictably as consumption/leisure changesFurther, house possess some non-labor income (i.e. asset income).Households maximize utility subject to an income constraint.

Note that the choice for labor will determine the level of consumption possible.


Suppose that the hourly wage is varies predictably as consumption/leisure changes$10 and that consumption goods cost $2. Further, you have $20 of non-labor income. Assume you have 1 hour of time available.

L = 1: you work as much as you can

15

10

0

1

L = 0: You don’t work at all


Recall that maximizing anything requires equating costs and benefits at the margin

How much is an extra unit of consumption worth to you?

How unhappy does working an extra hour make you??

How much extra consumption will an extra hour of work buy you? (i.e. the real wage)

A little rearranging….


At the optimum choice for labor, the slope of the indifference curve is equal to the slope of the budget constraint.

Consumption

Real Wage

15

10

0

1

Hours of Leisure

Hours of Labor


Suppose the wage rate rises to indifference curve is equal to the slope of the budget constraint. $16 (non-labor income is still $20 and the price level is still $2). Does labor supply increase of decrease?

Substitution Effect: As the real wage increases, the price of leisure has increased relative to consumption – buy more consumption, less leisure.

Real Wage

18

Substitution Effect:

Income Effect:

Income Effect: As the real wage increases, your purchasing power goes up. Buy more of both goods (consumption and leisure)

10

0

Hours of Leisure

Hours of Labor


We typically assume that the substitution effect is dominant…a rise in the real wage increases hours of labor supplied.

Real Wage

18

10

0

Hours of Leisure

Hours of Labor


Suppose that the hourly wage is still dominant…a rise in the real wage increases hours of labor supplied.$10 and that consumption goods cost $2. However, Non-labor income increases to $40.

25

Real Wage

15

10

0

Hours of Leisure

Hours of Labor


An equilibrium in the labor market is defined as a real wage where labor supply equals labor demand (i.e. the labor market clears)

Note: This equilibrium assumes fixed values for productivity (A), capital (K) and non-labor income (NLI)


Note that once employment is known (capital is taken as fixed in the short run), output can be determined

1

Labor Markets

2

Production Function


We need to make assumptions about the evolution of productivity. Let’s suppose that productivity evolves according to an autoregressive process

Productivity shock

Persistence parameter


Suppose that the economy is hit by a positive productivity shock that is perceived to be temporary

For a given level of employment and capital, production increases

Rise in productivity


Suppose that the economy is hit by a positive productivity shock that is perceived to be temporary

With a rise in productivity, at the initial real wage, demand for labor rises

Non-Labor income is (relatively) unaffected

Rise in productivity


Suppose that the economy is hit by a positive productivity shock that is perceived to be temporary

Non-Labor income is (relatively) unaffected

Rise in productivity

The rise in labor demand increases employment and real wages


An increase in productivity that is permanent will have a larger effect on non-labor income, and create a decrease in labor supply

Non-Labor income increases

Rise in productivity

The drop in labor supply creates a larger increase in the real wage and a smaller effect on output and employment


Labor Markets and the business cycle larger effect on non-labor income, and create a decrease in labor supply

Given the mechanics of the labor market, what relationships would we expect to see between productivity, wages, employment, and output?

Just the facts ma’am.


GDP vs. Employment (% Deviation from trend) larger effect on non-labor income, and create a decrease in labor supply

Correlation = .84


GDP vs. Productivity (% Deviation from trend) larger effect on non-labor income, and create a decrease in labor supply

Correlation = .66


GDP vs. Real Wages (% Deviation from trend) larger effect on non-labor income, and create a decrease in labor supply

Correlation = .18


The low correlation between real wages and GDP suggests that labor supply is very elastic

Random productivity fluctuations in labor productivity cause large employment movements, but very little change in the real wage


Example: Oil Price Shocks in the 1970’s labor supply is very elastic

1979 Iranian Revolution

(Temporary Shock)

Dollars per Barrel

1973 Arab Oil Embargo

(Permanent Shock)


This dramatic rise in oil prices can be thought of as a negative productivity shock. Remember, we are measuring GDP by value added. When energy costs go up, value added goes down

  • This temporary drop in labor productivity caused a decrease in labor demand

  • A temporary shock creates a small income effect and, therefore, no change in labor supply. If the shock were more permanent, a rise in labor supply would push the real wage even lower


Real Compensation (1972 – 1982) negative productivity shock. Remember, we are measuring GDP by value added. When energy costs go up, value added goes down

% Deviation From Trend

1979 Iranian Revolution

1973 Arab Oil Embargo


Employment (1972 – 1982) negative productivity shock. Remember, we are measuring GDP by value added. When energy costs go up, value added goes down

% Deviation From Trend

1973 Arab Oil Embargo

1979 Iranian Revolution


% Deviation From Trend negative productivity shock. Remember, we are measuring GDP by value added. When energy costs go up, value added goes down

1979 Iranian Revolution

1973 Arab Oil Embargo

GDP (1972 – 1982)


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