Chapter 7 Outline The Labor Market 7.1 A Tour of the Labor Market 7.2 Movements in Unemployment 7.3 Wage Determination 7.4 Price Determination 7.5 The Natural Rate of Unemployment 7.6 Where We Go from Here
APPENDIX Wage- and Price-Setting Relations versus Labor
The Labor Market • We have focused on the short run by assuming a constant price level in the IS-LM model. • We now turn to the medium run and explore how prices and wages adjust over time, and how this in turn affects output. • The labor market is the center of that sequence of events.
7.1 A Tour of the Labor Market (1 of 4) Figure 7.1 Population, Labor Force, Employment, and Unemployment in the United States (in millions), 2018 The unemployment rate is the ratio of the unemployed to the labor force. The 2018 rate was 6.3/155.7 = 3.9%.
Source: Current Population Survey http://www.bls.gov/cps/.
7.1 A Tour of the Labor Market (3 of 4) Figure 7.2 Average Monthly Flows between Employment, Unemployment, and Non-participation in the United States, 1996 to 2018 (Millions)
(1) The flows of workers in and out
of employment are large. (2) The flows in and out of unemployment are large relative to the number of unemployed. (3) There are also large flows in and out of the labor force, much of it directly to and from employment.
Source: Calculated from the series constructed by Fleischman and Fallick,
FOCUS: The Current Population Survey • The Current Population Survey is the main source of the Labor Department’s statistics on labor force, employment, participations, and earnings in the United States. • It is based on about 60,000 households interviewed every month. • Economists use these data to get snapshots of the economy at various points in time, and how the same people do in two consecutive months.
7.3 Wage Determination (1 of 6) • Sometimes wages are set by collective bargaining—a bargaining between unions and firms. • Slightly more than 10% of U.S. workers’ wages are set by collective bargaining. • The higher the skills needed to do the job, the more likely there is to be bargaining between employers and individual employees. • Collective bargaining plays an important role in Japan and most European countries.
7.3 Wage Determination (2 of 6) • Workers are typically paid a wage exceeding their reservation wage—the wage that would make them indifferent between working or being unemployed. • Wages typically depends on labor-market conditions: The lower the unemployment rate, the higher the wages. • Workers’ bargaining power depends on: – How costly for the firm to find other workers – How hard for workers to find another job if they were to leave the firm
7.3 Wage Determination (3 of 6) • Efficiency wage theories link the productivity of the efficiency of workers to the wage they are paid. • Firms may want to pay a wage above the reservation wage in order to decrease workers’ turnover and increase productivity. • Firms that see employee morale and commitment as essential to the quality of workers’ work will pay more than those whose activities are routine. • When unemployment is low, firms that want to avoid an increase in quits and will increase wages to induce workers to stay with the firms.
Source: Dan Raff and Lawrence Summers, “Did Henry Ford Pay Efficiency Wages?” Journal of Labor Economics 1987 5 (No. 4 Part 2): pp. S57–S87.
• In 1914, Henry Ford, the builder of Model-T, announced that his
company would pay all qualified employees a minimum of $5.00 a day for an eight-hour day, compared to previously an average $2.30 for a nine-hour day. • The turnover rate plunged from 370% in 1913 to 16% in 1915. • Amazon raised wages in a similar manner in October 2018.
7.3 Wage Determination (4 of 6) • The aggregate nominal wage W depends on: – the expected price level Pe – the unemployment rate u – a catch-all variable z = , (7.1) (−, +)
7.3 Wage Determination (5 of 6) • Both workers and firms care about real wages (W/P), not nominal wages. • The nominal wage depends on the expected price level (rather than the actual price level) because when nominal wages are set, the relevant price levels are not yet known.
7.3 Wage Determination (6 of 6) • An increase in the unemployment rate decreases wages. • Higher unemployment either weakens worker’ bargaining power or allows firms to pay lower wages and still keep workers willing to work. • z stands for all the factors that affect wages given the expected price level and the unemployment rate, for example: – unemployment insurance as the payment of unemployment benefits to workers who lose their jobs – employment protection makes it more expensive for firms to lay off workers
7.6 Where We Go from Here • We have assumed that the price level is equal to the expected price level. • In the short run, the price level may well turn out to be different from what is expected when nominal wages are set, so that unemployment is not necessarily equal to the natural rate or output equal to its natural level. • Because expectations are unlikely to be systematically wrong, in the medium run, output tends to return to its natural level. • The next chapter will relax the assumption that the price level is equal to the expected price level.
APPENDIX: Wage- and Price-Setting Relations versus Labor Supply and Labor Demand (1 of 3) • The representation of labor-market equilibrium in terms of labor supply and labor demand in microeconomics is similar to the representation of the labor market in terms of wage setting and price setting. • To see this, we redraw Figure 7.6 in terms of the real wage on the vertical axis and the level of employment (N) on the horizontal axis. • Unemployment U is the labor force (L) minus employment N, i.e., U = L − N.
APPENDIX: Wage- and Price-Setting Relations versus Labor Supply and Labor Demand (2 of 3) Figure 1 Wage and Price Setting and the Natural Level of Employment
APPENDIX: Wage- and Price-Setting Relations versus Labor Supply and Labor Demand (3 of 3) • The wage-setting relation is now upward sloping: Higher employment implies a higher real wage. • The price-setting relation is still a horizontal line. • The equilibrium is given by point A, with “natural” employment Nn. • The price-setting relation looks like a flat labor-demand relation.
